Warm winter, fashion plateau dampen retail sector

Cape Town - A warmer southern hemisphere winter and changes in fashion trends are to blame for the underperformance of South Africa’s retail sector, said William Bell, senior analyst at Sanlam Private Wealth.

Although clothing retail shares are starting to look “interesting again” from a valuation perspective, Bell cautions that investors should still regard it as a beleaguered industry. “There may be more upside potential in other sectors, such as banking if there’s a recovery in consumer confidence.”

The El Niño weather phenomenon that caused warmer southern hemisphere winters has caused a reduced demand in winter clothing, while clothing retailers worldwide are lamenting the lack of significant changes in fashion trends over the past few years.

“The last major change – the skinny jean – has been in fashion for more than a decade,” Bell said.

Another major challenges for clothing retailers are consumers’ declining disposable income, aggravated by the weak rand, which has materially increased the selling prices of imported clothing. Consumers are making trade-offs in their monthly spending patterns, with less income going towards buying clothing.

The entry of international fashion retailers into South Africa, such as H&M and Cotton On in particular has found good “early traction” on South African shores.

“The base is probably too small to have hurt local players yet but the growing presence of these foreign retailers shouldn’t be ignored.”

Bell said with the exception of the Foschini Group, which had a relatively weak 2015, many retailers performed poorly in the year to date. “Woolworths -19%, Truworths -18%, and Mr Price -20%. Interestingly, South African clothing retail shares didn’t fare that badly compared to our global counterparts: H&M -20%, Marks & Spencer -40%, and Zara -1% – all in rand terms,” he explained.

Sanlam Private Wealth, Bell said, views clothing retail shares as more interesting. “The average price-to-earnings (P/E) ratio fell from a high of about 25 times in early 2015 to 14.4 at present. Investors should take care, however, not to anchor their expectations to past share prices, as the sector is in fact now only trading in line with its longer-term average P/E and is still some way above bottom-of-the-cycle levels of around 8.5 times P/E.”

Although value has started to emerge in clothing retailers, there’s a much stronger valuation case in another locally focused and consumer-dependent sector, such as South African banking stocks.

“South African banks have a lower downside to historical trough levels,” Bell said, “so from a portfolio management perspective, we have over the past year preferred to add to our exposure to banks, which in our view have offered more upside in the event of a South African consumer recovery.”