Interactive Investor

Investors are buying up these retail stocks

4th January 2023 13:44

Graeme Evans from interactive investor

Consumer spending is under pressure, but there are hopes that Christmas trading was better than feared. Our City writer rounds up the action from the UK retail sector.

A retail sector on its knees in October continued to attract buying interest today as hopes build that festive trading has not been as bad as investors feared a few weeks ago.

Currys (LSE:CURY) and Marks & Spencer Group (LSE:MKS) were among stocks making headway, while WH Smith (LSE:SMWH) benefited from Deutsche Bank analysts strengthening their “buy” case with a new 1,690p target.

The sector’s reporting season gets under way tomorrow with Next (LSE:NXT) and B&M European Value Retail SA (LSE:BME), but the absence of retail profit warnings in the first two trading sessions of the year suggests autumn’s worst-case expectations have been avoided.

The mood was further helped today by a stronger pound and figures from the British Retail Consortium boosting hopes that non-food price inflation may have peaked in December.

Retail stocks remain significantly lower than where they stood a year ago, but there’s been a marked improvement in valuations compared with the period when mortgage rates were on the march in the aftermath of the mini-budget turmoil.

M&S, for example, has rebounded from a near pandemic low of 93.2p in mid-October to stand at 130p this morning. In the FTSE 100 index, Next has jumped by 38% to above 6,000p.

In a recent sector-wide note, broker Peel Hunt said: “Against the context of sector downgrades and a very poor summer, autumn trading has proved to be more robust than feared.

“Flat sales and high single-digit volume declines may not be cause for celebration, but it is the mid-point of our scenario analysis and a step ahead of where worst-case expectations had  been pitched.”

Even if Christmas has been better than feared, there’s little respite ahead as consumers scale back spending in 2023 to cope with higher interest rates, energy costs and general inflation.

Peel Hunt added: “Retailers are contending with exactly the same pressures, albeit the sharp drop in freight costs is providing one of the few cost tailwinds.”

Its top picks include Dunelm Group (LSE:DNLM), JD Sports Fashion (LSE:JD.), Dr. Martens Ordinary Shares (LSE:DOCS), Pets at Home Group (LSE:PETS), Halfords Group (LSE:HFD) and WH Smith, all of which offer top-quartile return on capital employed and cash generation.

The broker adds that their average price/earnings multiple has fallen from over 20 times to 12 times, despite limited impact on their average earnings progression.

WH Smith also has the support of Deutsche Bank, which today upgraded its expectations for 2023 profits to £131 million from £110 million and lifted its share price target by 22%.

It described the FTSE 250-listed company as a more resilient way to gain exposure to the structurally attractive travel retail sector.

The bank has upgraded its expectations for first-half trading, although some of the progress over the peak travel season will have been dented by UK transport industrial action and travel delays.

WH Smith recently swung back to profit and reinstated dividend payments, reflecting the benefits of its Travel arm now being a very different business to the one when Covid hit.

This strategy has been built around the technology-focused InMotion brand, a US-based business bought by WH Smith in 2018. There are now over 150 InMotion stores open, including 36 outside the US.

It also expects its North America operations to become larger in profit terms than its UK high street business during the current financial year, with significant opportunities to grow this business further.

The return of near normality in air travel has been a particular boon for the company, It also benefits from “captive” customers in many of its other key sites, such as railway stations, motorway service and hospitals, which sets it aside from much of the retail competition.

Despite a more cautious view of consumer spending in 2023, Deutsche Bank believes the travel business is strongly positioned to continue to take market share.

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