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Falling household spending power prompts downgrades for UK retailers

Published: 11:45 06 Sep 2022 BST

Associated British Foods PLC -

A fall in the discretionary spending power of households as a result of the energy crisis has prompted Jefferies to downgrade the ratings and price targets for a number of UK retailers, including Tesco, Sainsbury and Primark owner AB Foods.

The broker estimates that at current energy prices income available to UK discretionary expenditure will contract by around 6% in 2023/24 despite 5.5% earnings growth and a major hike in energy subsidies from the new Government.

Jefferies has, on average, reduced profit forecasts for 2023/24 by 22% and cut ratings on Associated British Foods PLC (LSE:ABF), Kingfisher PLC (LSE:KGF), J Sainsbury PLC (LSE:SBRY), Tesco PLC (LSE:TSCO) to 'hold' from 'buy', B&M European Value Retail SA (LSE:BME) to 'underperform' from 'hold', whilst it has kept Marks and Spencer Group PLC (LSE:MKS) and Next PLC (LSE:NXT) at 'hold'.

The broker said “these are all resilient businesses with strong finances. But short term prospects look tough.”

Jefferies said the two key areas of pain for UK consumers will be utilities costs and mortgage payments.

The broker said it assumes the incoming government will largely cover consumers’ extra energy outgoings but noted energy costs are set to represent an enduring inflationary headwind.

The caveat to all of this, Jefferies said, was how politicians react adding there are signs “politicians are starting to grasp the gravity of the challenges ahead.”

Political action could mean “our embedding of the current economic reality may prove short-lived.”

Price targets for the retailers have been cut as follows: Tesco 260p from 350p, Sainsbury 210p from 300p, AB Foods to 1500p from 2000p, B&M European Value Retail to 300p from 400p, Kingfisher to 240p from 335p, Marks and Spencer to 115p from 170p and Next to 5500p from 6350p.

Elsewhere analysts at Berenberg also put out a bearish note on the 'consumer discretionary' super-sector, noting that "the macro environment has deteriorated significantly, with geopolitical tensions, supply disruptions and surging energy prices, all dealing a major blow to the global outlook".

While consumer spending has so far remained "remarkably resilient", this has created "a false sense of security", the analysts said, with , headwinds now felt to be growing.

With a consumer slowdown now looking "inevitable", Berneberg said "investors are bracing themselves for the downgrades".

In a note to clients, the German bank embedded a recession scenario in its forecasts, moving them 15% and 10% below the analyst consensus on average for 2023 and 2024 earnings respectively, while also assessing the risks and opportunities for companies in a recession, with top picks in the sector being JD Sports Fashion PLC (LSE:JD.) and French groups EssilorLuxottica and Kering, while Adidas was downgraded to 'hold' and H&M to 'sell'.

In the "cost-of-living" crisis, the worst is still to come, Berenberg said, with the UK facing the most significant headwinds.

Discretionary spending in the UK will fall by 13% in 2023, the analysts calculated, with the decline most severe for those on lowest incomes, and higher incomes "more sheltered, but not immune".

"This analysis could be too optimistic if energy prices and interest rates continue to rise. However, there could be relief from accumulated savings, higher use of credit and government stimulus".

Europe is predicted to be affected to a lesser extent thanks to more government stimulus, with the US more insulated thanks to lower gas prices), China growing and other regions like Latin America, the Middle East and Asia-Pacific more resilient.

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