Jaeger failure, UK data underline negative retail outlook, says Fitch

The collapse of UK fashion retailer Jaeger and weak non-food sales figures from the British Retail Consortium (BRC) reinforce negative sector and ratings outlooks for the European retail sector, Fitch Ratings says.

Jaeger went into administration on Monday after private equity owner Better Capital failed to find a buyer. Its collapse follows a string of well-known UK retail failures, including BHS and Austin Reed, which have both gone into administration in the last 12 months.

The retail sector is facing challenging secular trends, including changing consumer spending habits, which have been a key factor in recent failures. Consumers are shifting to online shopping, and demand has reduced due to a growing preference among consumers to spend their money on experiences. This threatens the viability of traditional retailers that are unable to adapt quickly enough. Inflationary pressures from the depreciation of the pound are also likely to hit some UK retailers as their currency hedges expire.

In the non-food sector, this could be particularly significant for apparel retailers as around half of clothing purchases are billed in dollars. The latest figures from the BRC highlight the difficult trading environment. Non-food retail sales in 1Q17 were 0.8% lower than a year earlier, the worst quarterly performance in nearly six years. These trends will add to the pressure on profitability, with apparel companies among the most exposed alongside consumer electronics retailers. For example, Fitch expects New Look Retail Group 's EBITDA margin to have fallen to around 12.0% in the financial year to end-March 2017 (FY17), and only to recover to around 12.5% in FY19, from a high of 15.3% in FY15. Retailers are expected to respond by closing stores and reducing excess capacity in order to focus on store profitability. But any benefits from cost savings are likely to be reinvested in attracting customers through lower prices or higher levels of service.

This means that overall profitability is unlikely to improve across the sector and free cash flow will remain low, preventing any meaningful deleveraging. Leverage headroom is low across all ratings categories in Fitch's portfolio of non-food retailers, leading to an overall negative rating outlook for the sector. For low non-investment-grade companies, such as New Look and Financiere IKKS (CCC), which have locked themselves into highly leveraged capital structures, organic deleveraging will represent high execution risk in the near term.