Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

“If the UK high street wasn’t already on its knees, then the pandemic sounded the final death knell for its beleaguered retail sector.” So goes the conventional wisdom. Why would anyone want to invest in UK retail?

Such a generalisation fails to acknowledge both the booming fortunes of many British retailers over 2020, and the long-term recovery potential in some quality offerings that suffered. Far from dying, the British high street is simply changing.

For sure, the pandemic has left its mark. Some have boomed this year where others have busted. Earlier this month, we heard that Morrisons’ (MRW) sales coming into January were up 9.3% year on year - that same day, Paperchase, the stationary group, announced that it had filed for administration.

The pandemic has changed not only what people consume but also how they consume it. Successful stock pickers are savvy to these changes, while keeping a keen eye for quality fundamentals.

Here’s how you too can navigate this shape-shifting sector.

Discretionary vs essential

A key aspect of the retail landscape is the difference between discretionary and essential goods.

Essential goods are, as the name suggests, essential. They’re the products we can’t do without, regardless of whether we’re living through a pandemic or not.

Conversely, discretionary goods are those which go above and beyond what is considered necessary - cars and holidays, for instance.

This distinction goes some way to explaining the sector’s diverging fortunes. The logic is as follows - in the midst of a pandemic, shoppers will keep on buying essential goods, and forgo the discretionary. Essential goods may even profit at discretionary’s expense - think of all the additional money that has been spent at supermarkets this past year rather than at restaurants and pubs.

But that logic only goes so far. The 2020 recession was a recession like no other. While huge numbers of incomes and livelihoods took a battering, many households have actually built up their savings over the various lockdowns. Generally speaking, it’s not appetite to spend that’s been reduced but opportunity. Retailers who have been able to bridge the gap between pandemic and untapped savings were best positioned to succeed last year. This remains a vibrant, if challenged, sector.

Go online or go home

One way to get ahead last year was through selling online. Bringing your online offering up to scratch is now a near-must for retailers. That’s proven easier for some than others.

Take supermarkets. Supermarkets enjoyed a stellar year, topped off by a record-breaking December in which tightened restrictions saw consumers spend £11.7 billion on take-home groceries.

But even in this most bumper of markets, whose stores remained open throughout 2020, online capabilities proved a vital differentiator. Ocado (OCDO) was one of the biggest success stories of 2020. The company saw its share price soar almost 80% last year, so much so that in September it took Tesco’s (TSCO) place as the UK’s most valuable retailer. Please remember past performance is not a reliable indicator of future returns.

In large part that success came down to its superior online offering. When the pandemic hit, the online-only supermarket was well equipped to respond to the initial upsurge in demand, where others spent much of 2020 trying to catch up.

It’s a similar story across the sector. Consider the success of online outlet ASOS (ASC). The online-only fashion retailer attracted 3.1 million new customers in the 12 months to August, while its sales in the four months to December rose 23% to £1.3 billion (with UK sales growing 36%). Over 2020, its share price rose by over 40%.

Compare that with the difficulties faced by Associated British Foods (ABF), best known as the owner of clothing retailer, Primark. Primark has zero online presence. Admirable, perhaps - lines of shoppers seizing their chance to visit seldom-open Primark stores last year tell you there’s nothing wrong with the company’s brand. ABF is by most accounts a quality buy. But 2020 was not a good year for its flagship retail offering to rely solely on in-store sales.

Its share price fell almost 13% over the year. Further lockdowns this winter have compounded the company’s problems. At the end of December, ABF said it anticipated the fall in sales due to the pandemic would be even steeper than the initially projected £430 million.

The news stood in stark contrast to the sales figures posted shortly after by fellow clothing retailer, Next (NXT). Next revealed a 36% jump in online sales in the nine weeks to Boxing Day, compared to a year ago, almost entirely offsetting the fall in in-store sales. Remarkably, the company managed to increase its total sales in the second half of 2020 when compared with the same period in 2019 - through both online and physical stores.

Next is one retailer that has been able to develop a strong online offering while maintaining a solid physical presence. That puts it in a good position to cope with further lockdowns as well as a more flexible post-pandemic future.

Quality remains key

As Next and ABF demonstrate, online capacity is important, but it isn’t the be all and end all. As ever, solid fundamentals remain key.

Take one of the pandemic’s highest profile losers, Arcadia. True, the pandemic hasn’t helped the owner of Topshop and Edinburgh Woollen Mill, and the group were certainly slow to build up their online presence.

But Arcadia’s decline began long before the virus. For years, it’s been slow to keep up with the times - whether that’s the latest fashion trend or shifting consumer behaviours. Arcadia has struggled to make meaningful change over a period in which the entire retail landscape has transformed.

Cases like this remind us that quality and agility remain ever important. This is a harsh sector that will punish the stragglers, but there are meaningful gains to be made for those that can stay ahead of the curve and keep their models relevant. While the future remains uncertain, it’s key that stock pickers focus on how a company plans to adapt rather than how it coped in the past.

Five year performance

As at 30 Nov

2015-2016 2016-2017 2017-2018 2018-2019 2019-2020
Ocado -13.2 50.4 99.0 61.9 78.8
ASOS 43.8 35.3 -66.1 48.1 41.8
ABF -17.8 2.7 -27.5 27.2 -12.9

Past performance is not a reliable indicator of future returns

Source: Refintiv, as at 31.12.20, share price movement in GBP terms

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

Topics Covered:

UK; Shares; Active investing

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