The profitability of the UK retail sector is showing signs of stability, but challenges persist due to ongoing high inflation and consumer pricing pressures, according to a report by Fitch Ratings.

Smaller companies in the sector are finding it increasingly difficult to manage rising costs compared to their more diversified counterparts.

Consumer spending in the UK continues to face headwinds, primarily driven by high prices, increased interest rates affecting mortgage and consumer credit payments, and decreased savings that accumulated during the pandemic.

These factors are particularly impacting non-food retail categories.

While recent wage increases may offer some relief, the retail sector’s profitability is not expected to rebound quickly due to intense competition.

Food retailers find stability, non-food retailers face challenges

The report notes that most food retailers have managed to stabilise their margins throughout 2023, and this trend is expected to persist into 2024.

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By GlobalData

On the other hand, rated non-food retailers, expected to be hit the hardest, are projected to reach a floor in their margins by the end of 2023 but may not fully recover until 2024-2025.

Inflation pass-through has posed a significant challenge to the sector, with non-food retailers experiencing more significant impacts than their food retail counterparts.

Diverging prospects for retailers

The report reveals that while all retailers have implemented cost-saving measures, smaller grocers like Iceland, with thinner earnings before interest, taxes, depreciation and amortisation (EBITDA) margins of 2.9%, struggle more with cost inflation compared to larger, more diversified grocers with EBITDA margins of 5%-6%.

UK retailers have been conservative in their capital expenditures in 2023, focusing on maintenance, warehouse and store automation, as well as strengthening their online channels.

Store expansion has been limited, with some companies investing in smaller convenience store segments. These trends are expected to continue into 2024.

Rating challenges and debt reduction efforts

Fitch Ratings notes that the majority of ratings in the UK retail portfolio are clustered in the ‘B’ category due to pressures stemming from high costs, competition, and elevated leverage.

However, exceptions include Tesco and Kingfisher. Tesco’s rating benefits from its strong market positions in the UK and parts of Europe, along with favourable leverage. Kingfisher’s rating reflects its leadership in home-improvement retail and a conservative financial approach.

Several retailers across the rating spectrum are aiming to reduce debt in 2023-2024 to mitigate the impact of higher interest charges. Notably, Iceland’s WD FF Limited and EG Group plan to reduce their EBITDAR gross leverage in the coming year, indicating efforts to enhance their financial positions.