There are some strong reasons to invest in the retail sector, analysts at RBC Capital Markets believe, but not in Next PLC (LON:NXT) and Dixons Carphone PLC (LON:DC.), which were both downgraded.
In RBC’s 97-page “industry primer” covering the €1trn European general retail sector on Tuesday morning, Next was cut to ‘sector perform’ from ‘outperform’ as analysts expressed “some concerns about the outlook for next year”.
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Sentiment on the FTSE 100 group is expected to continue to swing back and forth “as it is perceived either as a strong online and cash returns story, or as a mature, over-earning department store”.
RBC cut its target price to 6,800p from 6,700p and noted the shares have enjoyed a strong run, up 20% over the past four months, lifting Next’s valuation above its historic average.
Next was observed to be taking more market share from Marks & Spencer Group PLC (LON:MKS) as its relative pricing “become more competitive”.
This is partly explained by the change in Next’s customers: “Whilst over 25 years ago, the average age of the typical Next shopper was around 20 years old, now she is at least 45 and getting older. Often we think it’s the same shopper.”
“The challenge for Next will be to retain its younger shoppers as its customer base gets older.”
Dixons Carphone was also downgraded to ‘sector perform’, with the share price target kept at 135p, “as there is less valuation upside now to our price target”.
Wider trends
In its wide-ranging note, RBC observed some historical trends and singled out new trends that are shaping the industry and opportunity for investors.
“Historically investors have made money trading UK General Retail as an early cycle sector, which has tended to outperform in late stage bear markets and early stage bull markets.
“Sentiment is still depressed owing to Brexit risks, but our preference right now would be for companies showing structural growth.”
Four areas were highlighted at providing this growth and offering the “biggest money making opportunities”: online, discount, travel retail and ‘athleisure’.
Of these, discount attracted customers during the financial crisis “and has managed to hold onto them ever since”, with B&M European Value Retail (LON:BME) offering a valuation at the low end of historic ranges due to investor concerns over the consumer outlook but providing an opportunity to buy.
The same is said for WH Smith PLC (LON:SMWH) in travel retail, a sub-sector that “has proved to be immune so far from share gains by Amazon and other online retailers”.
“We see [SMWH) as relatively well positioned in an uncertain political environment due to its low basket size and as it operates predominantly in captive markets.”
In athleisure, which has grown amid the “shift to healthy lifestyles and the casualisation of society”, RBC picked out JD Sports Fashion PLC (LON:JD.) as one of the few UK retail success stories overseas.
Raising its target for JD to 850p from 800p, analysts said the market “has underestimated its international expansion potential” and the margin recovery opportunity for US acquisition Finish Line.