Changing landscapes: from BREXIT to high yield via the sales.

Takeaways: Our world is changing rapidly and unpredictably. We’ve picked a few areas to highlight this week, starting with a startling BREXIT poll that could reflect a broader inward turn across Europe. The UK’s version of Black Friday will be a reflection of retail’s changing landscape – turned up to 11. Moves in high-yield markets are more subtle, but have fundamental undercurrents. The UK’s Autumn Statement will reshape the state.

The record level of deals we’ve seen in 2015 has been inspired by a delicate balance between rapid change and rising confidence. There has been enough challenge in the market to inspire M&A, but not so much that it topples investor confidence. Rising geopolitical uncertainties and growth risks could upset this delicate balance. Deals should only come to a halt in extremis – there is too much rationale to transact; but companies may need to work harder for financial and shareholder backing as we move into 2016 – especially for leveraged deals. 

EU referendum: BREXIT on?

The tragic events of the past few weeks have made the world seem a more frightening and unpredictable place.  There are obvious exceptions, but history suggests that populations often react to threats by turning inwards and looking to protect their interests and borders.  So it’s no surprise that the latest poll from ORB shows that just over half, or 52%, of UK voters they surveyed want to leave the EU, while 48% said they want to stay. This is an almost exact reverse of a poll a month ago, which showed 53% wanting to stay and 47% wanting to leave.

This is the first time the majority of those polled by ORB have said they want to leave the EU in six months of asking. This month’s result might just be an immediate reaction to events in Paris that will fade over time. But it would be wrong to assume that a ‘stay’ vote has a default majority – particularly as the EU landscape is likely to remain in a state of flux for much of 2016.  The UK isn’t the only country changing tack. We’ll be returning to this topic in the New Year, but in the meantime would be interested to hear your thoughts on whether BREXIT is rising up the corporate agenda.

 Retail: The most wonderful time of the year?

Retail’s golden quarter has been rather lacklustre so far. Some results have shone out amidst the gloom, but overall, retail sales figures show a slow start in October that’s extended into November. This lack of sales momentum will come as no surprise to anyone with online accounts with major retailers, who have been trying – it seems in vain – to lure in shoppers with deals, ahead of this week’s Black Friday. Thus, this US-import stands accused of distorting  sales, causing two dips – October and early December – and two strong peaks in Black Friday week (it is a week) and the final week before Christmas. As our chart shows, final quarter trading has long been lumpy by month – retailers should be well used to this. Nevertheless, it does appear that the advent of Black Friday has amplified weekly volatility –  perhaps even more so this year when many shoppers pay days will fall on peak trading days.

BRC sales YoY rise 2012-15Indeed, many of the challenges represented by Black Friday are a microcosm of those already in the changing retail landscape – just turned up to 11.  Our latest EY Retail insights paper   highlights some of the main challenges and looks at how retailers can still thrive in this environment. Most retailers agree that Black Friday doesn’t create new sales, so the main challenge is the familiar one of protecting margin whilst still holding market share – just in a much more extreme discounting environment.  Some retailers will be able to turn this shopping peak to their advantage – by luck, if not judgement. The cold snap has come just in time for clothing retailers, who will welcome a ready-made event to help them to clear rails still full of winter stock and (hopefully) limit margin dilution. Although, it’s retailers with a robust plan who tend to do perform the best and electrical retailers have been some of the biggest users of the ‘buy-in product’ strategy to protect margins. The challenge here is, as always, to ensure that quality and reputation isn’t dented ….which brings us on to fulfilment.

One of the greatest current challenges for UK retailers is to know how much to invest in online versus physical assets and how to meet rising consumer fulfilment expectations –  whilst still remaining competitive on price. The challenge is amplified considerably when UK shoppers are estimated to spend £2bn plus across a single long weekend with two-thirds of that forecast to be online.  Black Friday will expose any weaknesses and we expect retailers to have invested heavily – but at what price? We’re starting to see many more companies talk about the impact of increasing fulfilment and returns handling costs, and with further pressure on margins to come with the introduction of the National Living Wage (NLW).  Thus, many retailers are clearly still battling to maintain and build their bottom line results – despite a stronger consumer outlook – and we believe that a strong focus on operational efficiencies and capitalising on innovation, technology and data will prove to be real differentiators.

Rising defaults: Mainly oil, broader consequences…

HY US debt yieldsAccording to Standard & Poor’s, 99 companies have defaulted so far in 2015 – the most since 2009, when 222 companies couldn’t meet their obligations.  Of course, stressed US shale companies feature heavily in this total. Of the 99 companies, 62 are from the US and around 60% of these are energy and natural resources businesses. But, before we discount this as a localised problem, it’s worth remembering that we’re seeing stress along the supply chain. UK manufacturing companies have featured heavily in profit warnings on the basis of commodity price falls. Not just companies on the margins, but market leaders. Moreover, this  rising number of defaults may also have broad consequences for refinancing and further deals. 

High debt yields are rising. Not sharply across the board, obviously energy and natural resources have seen the biggest sell off and – as our chart shows – investors have more faith at the higher end of the spectrum. So you could interpret this as a return to more realistic pricing, rather than a portent of doom – although even more realistic pricing could claim some victims.  And, on the ground, it’s getting harder to do deals. Banks have been forced to offer more favourable terms to attract portfolio managers. The $5.5b sale of debt to finance this year’s largest leveraged buyout –  Carlyle’s carve-out of Veritas from Symantec –  has failed to get away.  This isn’t all about oil.

Autumn Statement: reshaping the state

Our Autumn Statement coverage kicked off this week with a preview from the EY ITEM Club. It’s tough to second guess the Chancellor, given last minute additions to the defence and security budget and the enforced rethink on tax-credits. What is clear is that he has little room to manoeuvre and significant cuts to make, if he is to meet his previously established spending targets. These imply spending cuts from unprotected departments of £23.7bn or 18.8% by the end of the decade.  Outsourcers will be on tenterhooks. The sector was born out of the last major reshape of the state in the 1980s. This latest spending review will likely open up substantial opportunities; but cost cutting means margin will be an issue here too – especially for companies with NLW exposure.