Buyer be­ware: value traps abound on the high street

The Daily Telegraph - Business - - Business Comment - TOM STEVEN­SON Tom Steven­son is an in­vest­ment di­rec­tor at Fidelity In­ter­na­tional. He tweets at @tom­steven­son63

Iwas mod­er­at­ing a panel dis­cus­sion last week at which my col­league Jeremy Podger, man­ager of our Global Spe­cial Sit­u­a­tions Fund, was asked to name two value traps. He thought for a while and replied, “any­thing that de­pends on the in­ter­nal com­bus­tion en­gine – oh and most of the high street”.

This is a good time to be think­ing about value traps – shares that look more of a bar­gain than they re­ally are. The rapid pace of tech­no­log­i­cal and cul­tural change means there are many busi­nesses that ap­pear to have fallen on tem­po­rar­ily hard times but that in re­al­ity will never re­cover. They are cheap for a rea­son. Their world has changed ir­re­vo­ca­bly.

The time hori­zons of Podger’s two value traps are dif­fer­ent. Petrol en­gines (al­though per­haps not diesel) will be with us for a few years yet, I sus­pect. But hardly a day passes when we are not served fur­ther ev­i­dence that the re­tail sec­tor is in cri­sis.

The few crumbs of good news, like Tesco’s re­turn to health, are the ex­cep­tions that prove the rule. The pit out of which Tesco is crawl­ing il­lus­trates the deep-seated prob­lems re­tail­ers face. Once the dom­i­nant force in UK food re­tail, it had big am­bi­tions to repli­cate its suc­cess around the world. It bus­ied it­self with moves into ad­ja­cent ar­eas from restau­rants to bank­ing. Tak­ing its eye off the ball in this way, Tesco made such a Hor­licks of things at home that just get­ting prof­its back to a third of their for­mer glory is seen as a tri­umph. Been down so long, it looks like up to me.

Rarely has a sec­tor faced such a per­fect storm of neg­a­tives. Here are half a dozen:

Top of the list is, of course, the Ama­zon ef­fect. Toys R Us con­firmed last week that it will close its re­main­ing stores in the UK, at the cost of 2,000 more jobs. The demise of the big-box toy re­tailer is not just about the shift on­line but it has been a sig­nif­i­cant fac­tor. Mother­care, too, is a vic­tim of the rel­a­tive ease and con­ve­nience of in­ter­net shop­ping. Just the growth in Ama­zon’s sales last year was big­ger than the to­tal mar­ket value of the 10 main re­tail­ers in Amer­ica’s shop­ping malls. Pres­i­dent Trump is right to worry about Ama­zon, even if he’s do­ing it for the wrong rea­son.

Next is what ap­pears to be a durable cul­tural shift away from buy­ing things, to do­ing them. Per­haps be­cause the old dreams of home own­er­ship have died for any­one un­der the age of 35, the de­sire to ac­cu­mu­late stuff within those homes has also per­ished. Young peo­ple want ex­pe­ri­ences not pos­ses­sions. Al­lied to this is the demise of shop­ping as a leisure ac­tiv­ity.

This rapid cul­tural change has been par­tic­u­larly hard to han­dle for the re­tail sec­tor be­cause it is struc­turally slow mov­ing. It is, for ex­am­ple, tied into long prop­erty leases that are ex­pen­sive to un­wind. For years, it in­vested heav­ily in an out-of-town shop­ping-mall in­fra­struc­ture that looks in­creas­ingly ir­rel­e­vant to mod­ern life­styles. As Car­petright’s chief ex­ec­u­tive Wilf Walsh said last week “we cre­ated an over-rented and un­sus­tain­able prop­erty port­fo­lio”. That was fine “as long as peo­ple were happy to visit a tin shed and spend on credit”.

The fi­nan­cial cri­sis put an end to that. The higher fi­nan­cial un­cer­tainty af­ter 2008 means that the cul­tural shift in what we spend our money on has been mir­rored by a change in how much stuff we buy and how much we are pre­pared to pay for it. There were many things Tesco got wrong be­tween the de­par­ture of Terry Leahy in 2011 and its re­cent re­turn to form, but fail­ing to grasp the ap­peal of the Ger­man dis­coun­ters Aldi and Lidl in an era of aus­ter­ity was cer­tainly one.

Other re­tail­ers have failed to live up to their cus­tomers’ raised ex­pec­ta­tions. WH Smith has been a rare suc­cess story in the sec­tor de­spite, not be­cause of, its core high street busi­ness. Sell­ing over-priced wa­ter and mag­a­zines to a cap­tive au­di­ence on the move through air­ports and rail­way sta­tions has dis­guised the poverty of its tra­di­tional shops. Last week’s re­sults showed that its dowdy high street out­lets are an on­go­ing drag. The cost of keep­ing a brand fresh and rel­e­vant is enor­mous.

The restau­rant sec­tor is an­other that is pay­ing the price for bor­ing its cus­tomers, with too many sim­i­lar for­mats. The cost of stand­ing out from the pack is just one fac­ing a re­tail sec­tor that is be­ing squeezed on mul­ti­ple fronts. A busi­ness that em­ploys so many low earn­ers is ob­vi­ously vul­ner­a­ble to in­creases in the min­i­mum wage. The anachro­nis­tic busi­ness rates regime is an­other heavy bur­den for the sec­tor.

So, while it is tempt­ing to see the re­tail sec­tor’s shares, stand­ing at multi-year lows, as a kind of mid­sea­son sale, in­vestors need to be very care­ful that they are not walk­ing into a clas­sic value trap. Against a list of the tra­di­tional red flags, bricks and mor­tar re­tail ticks most of the boxes.

First, it is strug­gling at a time in the eco­nomic cy­cle when it should be do­ing well. If re­tail is trou­bled at a time of low un­em­ploy­ment and lower in­ter­est rates, what hope when con­di­tions worsen? Sec­ond, its mar­ket share is fall­ing, the sign of a struc­tural, not a cycli­cal, prob­lem. Third, there is no ob­vi­ous cat­a­lyst for change. Value in­vestors need a re­cov­ery nar­ra­tive – there is none. Fi­nally, where are the ac­tivist in­vestors? There is a rea­son the vul­tures are not cir­cling yet.

The best in­vestors are con­trar­i­ans who know when to go with the flow. It is good to buy low, but not if cheap be­comes cheaper still. We fall into value traps when we don’t lis­ten to what the mar­ket is telling us.

‘If re­tail is trou­bled at a time of low un­em­ploy­ment and lower in­ter­est rates, what hope when con­di­tions worsen?’

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