Retail 2017 - a challenging road ahead?

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The British Retail Consortium (BRC) recently reported strong trading for the UK high street in the weeks leading up to Christmas 2016. In a fillip for a sector beset by problems, the slow start to the Christmas trading period was reversed as spending in the sector in December grew 1.7% on the same period last year.

Notwithstanding the Christmas boost and some retailers reporting strong pre-Christmas trading results, analysts agree that a combination of factors will mean that 2017 offers little respite for retailers. Property agent JLL has warned that the sector faces a "perfect storm" of rising costs against a backdrop of a falling consumer confidence and spending.

From April 2017 the National Living Wage will be increased from £7.20 to £7.50 per hour and is set to rise to £9.00 per hour by 2020. According to the BRC, this increase could cost the retail sector between £1.5 £3 billion a year. The apprenticeship levy, also to be introduced in April 2017, will tax large companies 0.5% of their payroll and will impact large retailers.

On 1 April 2017 new business rates changes will come into force following the first revaluation of rates undertaken since 2010. The revaluation, which is based on rentable values of properties as at 1 April 2015, will reflect the changes in property values since 2008. Businesses trading in London and the South East will be particularly badly hit given the dramatic rise in property values in the past few years, with the largest rises being well over 100% in some high value areas of London. Retailers trading in the more deprived parts of north and west of the country will be either unaffected or may even benefit from a rate cut. As the rate changes were only announced in Autumn 2016, retailers have been given little opportunity to renegotiate rents with landlords, reshape their leasehold portfolios or to formulate ways to absorb the increased costs. For national retailers, the high increases in the South and East may well outweigh the benefit of any rate cuts they receive in respect of their Northern property portfolio.

The devaluation of sterling following the Brexit vote will also put pressure on retailers as prices rise on imports; a factor whose impact has been delayed somewhat by currency hedges. However, as the pre-Brexit hedges begin to expire in Q2 of 2017 the reality of currency fluctuations will bite.

Retailers will be reluctant to hike prices in face of increased costs in a climate where consumer confidence in their spending power is showing signs of weakening. The BRC recently reported that, in the three months to December 2016, non-food sales had only risen by 1.3%, the sector's weakest performance since 2012. It also reported that the sale of big ticket items were slowing. According to the KPMG/IPSOS Retail Think Tank (RTT) inflation could potentially rise in 2017 to 3% and the RTT predicts that, if it does, this could result in an on average of 5 8% increase in retail prices. As a result, consumers are likely to become more conservative in their spending.

The way people shop for retail goods will continue to change in 2017. Ipsos reported, in their January 2017 Retail Traffic Index (RTI) that retail footfall for December 2016 was at its lowest since 1998 when the RTI was started. This statistic demonstrates the ongoing cultural shift of consumers moving to the convenience of online shopping. With online offerings able to compete strongly on price, consumers are increasingly savvy at searching the market for the best prices. Traditional bricks and mortar retailers facing numerous increased costs will find it increasingly challenging to compete purely on price but will need to adapt to find different ways to retain customer engagement in their businesses.

Commentators believe that fashion retailers are particularly at risk from these financial challenges. Figures from Opus Restructuring released in December 2016 state that 43.6% of fashion retailers in the UK are deemed to be financially vulnerable and are expected to face formal insolvency or undergo major financial maintenance over the next few years.

Against the backdrop of this challenging market, 2017 is likely to see structural and financial changes adopted by retailers as they reposition themselves in the market to maintain customer relevance and profit margins.

The RTT recently reported that, as a result in continued weaker sterling rates, in 2017, the UK Retail Sector could see an increase in interest from foreign investors looking to take advantage of lower valuations. Commentators also predict that we could see a rise in M&A work as rival businesses consider mergers to consolidate and cut costs.

For those retailers who are struggling it is likely that we will see them undertake programs of strategic closures of non-performing stores, and the use of company voluntary arrangements to restructure property portfolios and agree changes to lease terms with Landlords. This will have a consequential impact on the owners of shopping centres (often pension funds) especially in 'secondary' locations which are more likely to fall victim to such closure programs and will find it more difficult to re let units. Landlords will need to engage and work with struggling retailers to find a mutually acceptable position to preserve value in their own investments.

For those who are not able to adapt and restructure their businesses successfully, a rise in administrations and business failures seems likely.