Interactive Investor

Will these retailers outperform in 2024?

Retail stocks have performed well heading into the peak festive season, but will there be a new year hangover? A City bank has named its top long-term picks.

21st November 2023 13:31

Graeme Evans from interactive investor

Marks & Spencer Group (LSE:MKS), ASOS (LSE:ASC) and B&M European Value Retail SA (LSE:BME) have been given backing after a City bank urged investors to be more selective following the sector’s strong run.

While Deutsche Bank believes UK retailers are generally in good shape with margins set to continue their recovery in 2024, it said the anaemic growth outlook made the trio’s “specific and interesting investment cases” worthy of closer inspection.

It has “hold“ recommendations on Dunelm Group (LSE:DNLM), Next (LSE:NXT) and Kingfisher (LSE:KGF) in the rest of its retail coverage, having seen the wider sector rebound by about 25% so far this year.

The bank warns investors not to count on the same degree of sales and margin surprises in 2024. It added: “Christmas trading is likely to be robust, in our view, but there is a risk this represents the last hurrah of post-pandemic spending recovery.”

The “buy” recommendations favour businesses where valuations are yet to fully reflect the fundamental changes taking place within the respective operations. The appeal is boosted by new-found capital discipline, which should reassure investors.

M&S shares have already doubled this year but Deutsche Bank believes there’s further to go after highlighting a 310p target price.

As well as well-publicised strategic and operational changes coming to fruition, it adds that exposure to an older customer base offers resilience in the current market.

The bank said: “We have seen a number of times across the industry that when sales momentum builds it lasts for at least a couple of years.

“Whether M&S has changed to become a structural winner remains to be seen. It is not priced as such, leaving more upside on the table.”

After a choppy second half of the year for B&M shares, the bank regards the FTSE 100-listed company as its pick of the speciality retail sector based on a 23% upside to 660p.

In particular, the bank highlights the opportunity for B&M to take market share via new store openings and the transfer of sales following the Wilko administration. B&M has taken the route of special dividends rather than share buybacks, but Deutsche Bank believes this deserves to be encapsulated by a higher price/earnings multiple.

Today’s note added: “B&M has seen a step up in its margin profile, ambitious new store opening targets should deliver sector-leading sales growth over the next three years and structurally we see growth in the discount retail segment.”

The ASOS recovery is not so clear cut, but at this stage of its turnaround the bank has a target price of 500p for a potential upside of 27%. The shares are down by a quarter this year but have shown signs of stabilisation in recent weeks.

After a tough few years, Deutsche Bank said it believed the online retailer is evolving into a more disciplined and fashion-focused business.

It wrote: “The competitive environment has become tougher but we view the new "Back to Fashion" strategy as increasing the differentiation of the ASOS offer.

“The sales outlook and profit outlook for 2024 have been de-risked, in our view, given the updated guidance and the refinancing removes much of the balance sheet risk.”

On the three other stocks, it said it did not appear they have been overvalued as multiples are not stretched and expectations have not been carried away. 

Positives for the sector highlighted by the bank heading into 2024 include the cooling of interest rate expectations, the return of real wage growth and the support of high levels of employment in the UK.

On the downside it warns that higher remortgaging costs still need to feed through into the real economy for many households. In addition, there is less benefit from inflation in sales and operating costs within the profit-and-loss statement.

Margin benefits from FX, lower freight costs and cheaper sourcing are largely known and included within forecasts, while operating cost savings are getting harder to achieve after years of cuts. GDP estimates for the UK in 2024 also suggest limited growth prospects.

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