Individuals interact with few sectors of the economy more often than retailing. All of us need things; clothes, food and other essentials, and we must visit shops — online or in real life — to get them. Where and when is personal taste. But for new investors it can mean a false sense of security when it comes to understanding the market’s trade in company shares.
At its core, retailing is simple: buy from A and sell to B. The bigger the gap between the two the more money you make. This is called the gross or total margin. Out of that you must then pay your staff and other running costs. What is left afterwards is the net margin and this is what investors should be interested in.
Media reports about Christmas trading are incessant at this time of year. For the most part, they are unhelpful. Trading statements cover periods of varying lengths and are hard to compare. Information is usually only provided about sales. But high street fashion chain Next, which issued a trading update this week, is a welcome exception.
Full price sales rose 4.8 per cent in Christmas trading in the nine weeks to the end of last year, the company said. Customers turned out in droves for warm weather gear after a December cold snap. Sales had been expected to decline as pressure on shoppers’ pockets continues to grow. The surprise boost means an extra £20mn of pre-tax profits for shareholders, taking the total expected for the year to £860mn. On an earnings per share basis, profits for the year ending this month are 7 per cent higher. Investor approval sent shares up by the same amount on Thursday.
Therein lies the crux of successful retailing; profits today are what matter, not profits at some point in the future. Technology and low interest rates distorted this view in recent years, spawning businesses to drive sales growth and take market share at all costs. The strategies attracted interest and investors but many now appear excessive as net profits are needed to meet rising interest and other costs.
Investors should note the ephemeral nature of retail. Stores come and go. They have no intellectual property to give them a lasting advantage, although location remains important.
The key to making sustainable profits over the long term is protecting gross margins, thinks chief executive Lord Wolfson. That task is currently being made tougher as inflation pushes up suppliers’ costs. Next expects cost inflation to peak in the spring. The choice is either to pass these increases on to shoppers or absorb them and suffer losses in net profits.
Its decision to do the former is one reason Next expects sales to fall by 1.5 per cent over the coming year. Higher interest costs for shoppers and broader inflation are hurting too.
Next also said it expects pre-tax profits for the coming year to fall to £795mn. But higher wages are expected to be the biggest drag, not lower sales. Additional labour costs may account for £67mn of the fall. Lower sales will only shave £23mn from expected net profits. New cost savings will help to cushion the drop.
There are other levers a retailer can choose to pull instead of preserving profits. Buying lower-quality merchandise is one. But that has proved a slippery slope leading to past retail flops.
As the economy sours, plenty more of these can be expected. But companies like Next, which last made a pre-tax loss in the early 1990s, appear a long way from joining them.
From bombers to bits and bytes
The Ukraine war has revived the threat of conventional conflicts for developed nations. That has been good news for aerospace business Airbus, which makes military planes. But the French group’s interest in buying a stake in the cyber security and big data arm of local peer Atos are out of whack. Cyber warfare is a different activity to the physical sort.
Software group Atos is the kind of vendor that acquirers like: distressed. The division for sale, called Evidian, has more in common with US tech companies than a maker of fighter jets. Even so a deal would not be material for the aerospace group.
Defence and space activity makes up just over a quarter of Airbus’s top line, though its separate helicopters unit has defence exposure, too. Within defence and space, the software businesses — within connected intelligence — make up an even smaller part.
Diversifications into cyber security are tricky for defence investors to value, as BAE’s purchase of Detica illustrated. Competence and cash flows are harder to assess than in military hardware.
Building jets is Airbus’s main activity. In the nine months to September 2022, this accounted for more than 90 per cent of group operating profits. Airbus has dabbled in software previously via its Skywise project, with US partner Palantir. Not much has come of this so far, says investment bank Jefferies.
Perhaps Airbus boss Guillaume Faury believes stake-building could pave the way to a purchase of Evidian. Atos chief executive Rodolphe Belmer may have resigned last year because the board resisted a trade sale and favoured a demerger.
Atos has already entertained at least one offer for Evidian. A bid led by consultants Onepoint valued Evidian at €4.2bn, which Atos rejected. That looks low compared with an estimate from Citi of €4.6bn including net debt and pension liabilities.
In its current form, the software group is burning cash flow at an average of €385mn annually until 2025, according to S&P Global estimates. There is a danger Airbus would help fund a rescue if it becomes too embroiled with Atos. That might please the French government but shareholders would suffer.
Lex Populi is a new FT Money column from Lex, the FT’s daily commentary service on global capital. Lex Populi aims to offer fresh insights to seasoned private investors while demystifying financial analysis for newcomers. [email protected]