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Profound changes to retail outlook sparks unlikely share picks for Morgan Stanley

Boohoo, Dunelm and Superdry are among retailers that “could get into financial difficulties” in a scenario where there is a second lockdown over Christmas, no vaccine and high unemployment for the next two years

Morgan Stanley -
The high street is a different place now...

Retail sector analysts at Morgan Stanley say long-term shifts in consumer spending patterns sparked by the coronavirus crisis are “so profound that it will render irrelevant most of the research we have ever written”.

This week's suggested lifting of lockdown measures does not represent the beginning of the end of the pandemic’s impact on the sector, the analysts said they now forecast a 62% decline in sector earnings for 2020, with earnings next year expected to be down 33% too.

To pick out which companies are best placed, the new focus is now on balance sheet strength for each retailer as well as “how it will be impacted by ongoing social distancing measures, how cyclical it is, how deep the recession is going to be and how consumer behaviour changes longer term”.

As such, the investment bank's top picks in the sector now include B&Q owner Kingfisher PLC (LON:KGF) and Marks & Spencer Group PLC (LON:MKS), two names that would have seemed unlikely top picks in most recent years but both were upgraded from ‘equal weight’ to ‘overweight’, where they join fellow top pick Associated British Foods PLC (LON:ABF), the operator of the Primark chain.

Based on current base-case financial forecasts, the biggest share price upside is seen at Dixons Carphone PLC (LON:DC.) and Superdry PLC (LON:SDRY) but they were both downgraded to ‘equal weight’ from ‘overweight’, while the analysts left both Boohoo Group PLC (LON:BOO) and Dunelm Group plc (LON:DNLM) at ‘underweight’ as they “look most overvalued”.

This group of four “could get into financial difficulties in a scenario in which there are is a second lockdown over Christmas, no vaccine was available until summer 2022, and very high unemployment until then”.

The contrast is offered by Kingfisher, M&S and AB Foods: “Although they offer less base-case upside than these other names, they are less levered and thus we believe offer less downside risk if the operating environment proves to be tougher than we envisage in our base case”.

In the coming months, the analysts expect social distancing measures of varying degrees of severity to continue until a vaccine has become widely available.

“But changes to consumers’ lifestyles, and thus their spending behaviour, are likely to last much longer. And the retailers we cover will generally emerge with weaker balance sheets and ill-configured store portfolios.

“They are, though, likely to face less competition, at least for a while.”

However, the analysts stressed that the fast-moving and multi-dimensional nature of the crisis meant they “have never had less conviction that we do currently”.

Having said that, there were some pretty big changes to target prices, with Superdry getting the biggest haircut, down 71% from 870p to 250p, followed by a 43% cut for Dixons from 220p to 125p. 

The target for top picks were also adjusted, with AB Foods cut 13% to 2,800p, Kingfisher by 6% to 230p and for M&S by 26% to 160p.

Quick facts: Associated British Foods PLC

Price: 2126 GBX

LSE:ABF
Market: LSE
Market Cap: £16.83 billion
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