Monday 17 November 2014

Supermarkets facing big store closure - Why the big deal?

Mark Price's predictions of big store closures in The Sunday Telegraph should be no surprise to NAMs that know their ROCEs.

Essentially, retailer share prices are driven by the rewards they generate for risk. In other words, if a retail (or any other) business fails to generate an adequate pre-tax Net Profit on the Capital Employed in the business, then the ROCE will fall, and with it, the share price.

This means that in the case of large space outlets, say 100,000+ sq. ft., it is vital that sales/sq. ft. of at least £1,000 p.a. are generated, otherwise that outlet will dilute the group's performance.

As NamNews readers will know, the structural changes taking place in retail, such as consumers buying less and shopping more often means that the cost of driving out-of-town becomes an increasingly expensive issue, and not just for cash-strapped shoppers. Moreover, given the economic uncertainties, and the increasing ease of buying online, shoppers have become increasingly attracted to discounters and convenience stores, closer to home.

As you know, retail is meant to be flexible, capable of responding to any change in consumer demand. 

Unfortunately, UK retailers made the mistake of building and holding large space retail units, where scale economies helped them to generate high net margins, as long as sales remained high. With the benefit of 20/20 hindsight, holding rather than selling and leasing back the store meant that it was put in the Balance Sheet as a capital item, part of the Capital Employed. This meant that high net margins were required in order to produce an adequate ROCE of 15% or more.

With falling sales in large outlets, resulting in the same overheads eating into the margin, the retailer is faced with the dilemma of finding alternative uses for some of the space - such as restaurants, entertainment, and leisure - the only proviso being that these alternative options generate at least £1,000+ per sq. ft. p/a.

Alternatively, suppliers can help by organising in-store theatre initiatives that drive sales to such an extent that the overall store's selling intensity is greater than £1,000 per sq.ft./annum.

Otherwise, the store closes, or is hopefully sold off to other businesses that can exceed the sales-to-space parameters of viable usage, in order that the remainder of the estate, with a smaller footprint, can generate a level of ROCE that the City rewards via share price increases.

Failing that, the retailer slowly goes out of business..., whilst suppliers become stronger...

Unfortunately, and fortunately, it is as simple as that.  

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