Weak pound, a double edge sword for UK fashion retailers

The weaker than ever sterling might have helped some leading fashion players in the UK – including Burberry and Asos – but truth is that heavy discounts on debt issued by the likes of House of Fraser, Matalan or New Look reflect growing commercial pressure after Brexit and ahead the key Christmas trading period.

Bonds issued by department store House of Fraser last week joined unlisted fashion retailers New Look and Matalan in trading below 90 pence in the pound, indicating that bond investors are braced for potential losses on the debt, reported Reuters on Wednesday.

"This House of Fraser issue and news of heavy machinery renter Hewden coming under pressure could raise concerns of a post-Brexit impact on UK corporates," said Anthony Lawler, head of portfolio management at hedge fund investor GAM, commenting on the retailer’s performance. "Whether this is a one-off or a canary-in-the-coalmine is way too early to tell," he said in regards to the company’s bond, which value fell to 83 pence from 90 pence.

It’s worth recalling that House of Fraser also refinanced its debt last year, issuing a 175 million pound floating rate note that matures in 2020 as well as a 125 million loan and a 100 million revolving credit facility.

’Marmitegate’ effect to hit fashion retailers in the UK

With the value of sterling tumbling to a 31-year low against the US dollar following the EU Referendum, companies which import product or pay for materials abroad are now facing costs jumping by around a fifth, highlights ‘The Telegraph’.

Although some brands take pride on their locally sourced products – Burberry, Belstaff, Mulberry, just to mention but a few -, many British clothing and footwear retailers source the majority of their product overseas, which means that the pound’s nosedive has significantly increased the cost of sourcing or manufacturing for those retailers.

“For a business in the UK which has historically sourced leather for shoes in Italy, for example, it will certainly mean price increases”, warned Sally Britton, partner at law firm Mishcon, in a recent interview with ‘The Sunday Times’.

Analysts at Moody’s suggested that Next, Marks & Spencer, New Look and Matalan were most exposed to the post-Brexit plummet in the pound, since almost 70 percent of their stock is paid in dollars. Trying to mitigate these increased costs, a third of UK retailers questioned in a recent Barclays’ survey said they were considering switching suppliers as a consequence of Brexit.

Shop prices haven’t risen yet and we have just had the twenty-fourth straight month of clothes getting cheaper as a result of stiff competition and the intense fight between online and shops, but that will start to change soon”, says Stephen Robertson, chairman of Retail Economics.

Next, Matalan, and House of Fraser, the worst hit by Brexit

Next will be one of the first fashion players passing down increased costs to consumers, as the high street retailer has already warned that it is prepared to raise prices by as much as 5 percent next year following the sterling slump. “We’ve always taken the view that if our costs go up, then our selling prices will go up and vice versa", recalled the company’s CEO, Lord Simon Wolfson, in a tradeshow.

Fashion chains are seen as more exposed than other retailers because they could struggle to pass on cost increases from the pound's fall as the market has become reliant on discounts to clear stock after periods of unseasonable weather.

"It might be difficult for clothing retailers to make price rises stick especially if discretionary income is under pressure from inflation in other less discretionary spending like food explained Moody’s expert David Beadle in a research note.

Britain's Next reported sales on items without markdowns in its third quarter fell 3.5 percent and warned that the weak pound could increase the cost price of garments by up to 5 percent in 2017 in a worst case scenario.

House of Fraser reported sales for the eight weeks to Sept. 24 fell by 2 percent but said it was “cautiously optimistic” for the rest of its fiscal year, with the Black Friday and Christmas period usually accounting for about 85 percent of annual profit, highlighted Reuters in a report published Wednesday.

Meanwhile, affordable fashion chain Matalan, which runs 226 stores in the United Kingdom, is under even more pressure. In April, Matalan said it had amended conditions for a 50 million pound revolving credit facility with Lloyds after it was placed in the bank's support unit for troubled companies. Nevertheless, outstanding debts of 492 million pounds that mature in 2019 and 2020 are still trading at heavy discounts: 75.9 pence for the secured tranche and 65.5 pence for unsecured debt. "We expect they will need to actively consider refinancing options during the course of next year," said Beadle.

Major listed retailers such as Next and Marks and Spencer have also seen the price of their debt fall steadily in the last year, but Moody's says both can cope with lower profitability and higher costs. Both M&S and Next have a decent amount of headroom in their rating categories although they face the same challenges as the rest of the sector," concluded Beadle.

Burberry, Asos and Primark enjoin the Brexit momentum

On the upside, the wining vote to abandon the European Union has turned out to be a boon for upscale retailers in general and luxury fashion and accessories brands in particular.

Burberry is the most significant case, having enjoyed a jump in sales and profits in the last months as more foreign tourists are lured to the British capital by lower prices and more affordable luxury goods. The quintessentially British label registered an increase of 5 percent in the first half of the year, especially boosted by the good performance of the luxury brand in Europe and the Middle East.

The depreciation of sterling has also boosted jewellery and watches sales, which sales grew by over 16 percent in July.

On the other end of the spectrum, affordable fashion offered by Primark and ASOS has also experienced a noticeable jump in sales. The Irish chain Primark, owned by AB Foods, has already announced plans to increase its turnover by 11 percent in 2015, thanks to new openings that the company conducted during the second half of the year and the weakness of the pound.

Similarly, Asos was also favourably impacted by the new scenario, closing 2015 with a turnover of 1,445 million pounds and growing 27 percent in the UK.

Image:Burberry UK