Retail sector heading for big downer

The arguments for a downgrade across the retail sector are growing as the last remaining positive in the industry – the clothing retailers – are starting to take a hit from weaker consumer consumption and growing pressure on margins.

In a lengthy note from broker Singer Capital Markets the message was crystal clear – the sector is heading for a fall and it is now time to exit a growing number of retail shares. The company has downgraed its forecasts on 17 stocks (by as much as 10%) and this is against a backdrop of its numbers being 10% below City analyst consensus.

Taking the hit are Marks & Spencer, Home Retail and Topps Tiles, which join the Singer ‘Sell’ list comprising Asos and Carpetright. The broker has also downgraded JD Sports, Dunelm, Supergroup and Mothercare from ‘Buy’ to ‘Fair Value’.

These moves come despite the sector having underperformed so far in H2. But Singer reckons the risks on the downside will deliver even more gloom as the year progresses and we move into 2011.

Among its key concerns are:

• weak earnings trends on the back of a slack labour market
• input price inflation
• earnings inflation not keeping up with that of goods/services thereby eroding spending power
• rising interest costs in a weak mortgage market
• weakening house prices affecting consumer confidence
• return of price inflation in food

This cocktail of doom will likely result in like-for-like sales in the General Retail sector falling by 2.5% in 2011, which compares with a general expectation of negative 1.0% in 2010.

This makes it rather surprising that the sector is trading on a PE (price/earnings multiple) of 11x for calendar year 2011 (albeit skewed by highly-rated stocks like Asos), which puts it at a premium to the market average.

This could well be inappropriate when considering the dark clouds looming on the short and mid-term horizon. Even a buoyant Christmas may be insufficient to fend of this level of negative market characteristics.