Like war correspondents embedded in an army regiment, Berenberg’s retail analysts have spent three weeks on the front line of the embattled retail arena, “inside one of the UK’s best-performing fashion retailers learning from industry experts about the practicalities of retail”.
Now out of their combats and back into their white button-up shirts and blouses, the analysts shared the fruits gleaned from their deep-cover research with five “key takeaways” with read-across to stocks under their coverage.
These included a new perspective on Asos PLC (LON:ASC) that has resulted in a downgrade as the online retailer takes time to sort out its recent operational issues.
Looking across the wider sector battleground, the Berenberg retail brigade’s eyes have been opened to the “importance and impact people can make within a retail business”. While admitting it can be very difficult to assess this factor externally, the analysts said they “will be scrutinising these key areas more closely” from now on.
Paying attention to product
Product was the next epiphany, as product life cycles have accelerated and competition across the sector has increased, making picking fashion product winners more difficult.
“While the Inditex-style data-driven business model has its advantages, we believe investors have become overly focused on speed to market rather than an overall assessment of a retailers’ design, buying and merchandising capabilities,” the analysts felt.
“A successful strategy relies on strong designers and buying teams not only picking the winners, but backing them with sufficient order volumes. A retailer hedging its bets across a broad range of product can be as fatal as designing poor product in the first place. It is surprising, then, that retailers rarely, if ever, discuss their differentiation here.”
Retail marketing is harder than it looks
Another crucial revelation was about marketing, where timing to match availability of product “can be harder than it looks” and further complexity can stem from a brand’s relationships with its distribution partners; while creaking infrastructure “can make what appear to be simple tasks to outsiders more complicated in practice for many legacy retailers”.
Lastly comes product margin, which most retailers constantly track across every product line alongside sales performance, giving them far more control than investors might appreciate and where growing retailers have an advantage in terms of currency impact or input cost inflation over incumbents.
“Where a retailer has lost control of the product margin, it is therefore a significant indication of turmoil within the business in our view.”
Asos problems will take time
Asos was downgraded to ‘hold’ from ‘buy’ and its shares price target slashed to 2,500p from 4,000p after its latest profit warning as hopes diminish that its major infrastructure upgrade would bear fruit soon.
“While this upside risk remains, and ASOS has begun to strengthen its management team, this may take some time and consecutive profit warnings and ongoing execution issues may be indicative of cultural weakness.”
They added: “While fashion retailers can experience economies of scale with regards to fabrics and shipping costs, we can now also see material risk of diseconomies of scale, stemming from the complexity of scaling the buying and merchandising process.
“These problems are far from insurmountable, but we would wait for evidence that ASOS has tackled them, before recommending that investors should buy the shares.”
Primarni versus Marks & Sparks
Highlighting a winner in the sector, Berenberg alights on high street star Primark, part of conglomerate Associated British Foods (LON:ABF), which is a 'buy'.
“In order to guarantee low prices, it keeps its option count narrow and buys deep to achieve the greatest possible scale on every item it buys.
“This model is inherently risky, but relies on a buying team that knows its customer, and an ethos of “burying the dead” as it goes, marking down hard and clearing any excess inventory quickly.
“Its store managers are empowered to select product that they believe will sell in their store and mark down product where necessary. Importantly, store management teams are compensated on the basis of the net contribution of their own store.”
Further down the high street at Marks and Spencer (LON:MKS), the analysts’ experience over the last few weeks “has put into context the enormity of the challenge” and highlighting the critical importance hiring a top-class boss for the Clothing & Home arm.
“The Holly Willoughby denim saga, whereby M&S quickly ran out of stock for the best-selling range, was further evidence that M&S either does not understand what product its customers want, or does not have the right processes in place to execute, or both.
“Even when it has winners within its range, it is not backing them with sufficient buying to provide adequate availability. “