* Next has worst start to trading in 25 years
* Weaker pound, online shopping hurt traditional retailers
* Short-selling ticks higher in Debenhams, M&S
By Alasdair Pal
LONDON, Jan 4 The worst start to a trading year
for Next PLC shares since 1991 underscores the plight of
mid-tier UK retailers hit by a combination of fierce online
competition and higher costs driven by a weaker pound.
Traditional British stores, particularly those relying on
clothing, risk getting caught in no-man's land as
bargain-hunting consumers find cheaper alternatives while the
rising popularity of online shopping, now nearly a fifth of UK
retail sales, eats into their business.
Profit margins, already crimped by heavy discounting in
efforts to maintain market share, now face additional headwinds
as sterling weakness pushes up sourcing costs.
Next shares, down 18 percent in the first two trading days
of 2017, have fallen 41 percent in the past year. Debenhams
and Marks & Spencer are down about a quarter and
short-selling, where funds borrow shares and sell them in the
hope of buying back later at a lower price, has ticked higher in
The troubles echo a trend seen across UK grocers where
discount chains such Lidl and Aldi ate into the profits of
long-established chains such as Sainsbury, Tesco and Morrison.
While Next warned of tough times, B&M European Value Retail
said it enjoyed record Christmas sales.
At the top end of the market, John Lewis, Britain's biggest
department store chain which also runs upmarket grocery brand
Waitrose, saw sales in the week before Christmas soar 36
"It mirrors what happened in the supermarket space," said
Richard Marwood, a fund manager at Royal London Asset
Management. "It was the people in the middle who struggled."
Marwood, who owns B&M shares, said that the company is
enjoying the benefits of recent expansion but the jump in
like-for-like sales suggested it was attracting more consumers
looking for cheaper alternatives to traditional stores.
B&M, which sells products from toys to soft furnishings, is
a top pick in the European retail sector for analysts at
Deutsche Bank and Bank of America-Merrill Lynch.
Higher inflation and lower wage growth looks set to make
2017 "the year of value" in UK retail, according to analysts at
Deutsche Bank, which this week downgraded Next and Debenhams.
UK wage growth will fall below 1 percent in 2017, according
to the OECD, while inflation in food and fuel is set to pick up
- meaning consumers will have less to spend on discretionary
items like clothing.
Retailers buy a significant proportion of their goods in
U.S. dollars from manufacturers in Asia, selling on to British
consumers in pounds.
"The fundamental issue is that you've seen a nearly 20
percent trade-weighted depreciation of sterling over the course
of the last 12 months," said Jeremy Lawson, chief economist at
Standard Life Investments.
A weaker pound is a direct hit to profits. And in an already
tough environment retailers have little wiggle room on prices.
"They can hold the shop prices and hit margins, or they can
put up prices but will have an impact on volume of sales,"
RLAM's Marwood said.
Next is among those worst hit by currency moves, according
to analysts at HSBC, as it pays in dollars for around 70 percent
of its cost of goods sold.
Rivals like ASOS and Inditex, which source
more of what they sell closer to home, are poised to benefit and
grab market share by being even more competitive on prices,
analysts at Bank of America-Merrill Lynch said in a note to
Five hedge funds have significant short positions on
Debenhams totalling 7 percent, an all-time high, according to
latest data from the UK's market regulator, the Financial
Conduct Authority. On M&S, the ratio has more than doubled to
2.2 percent over the last three months of 2016.
High levels of bearishness do leave stocks susceptible to
bounces, however, if there is a rush of short-covering.
Also, with valuations already depressed, some investors are
not as downbeat on the sector.
Retailers "trade close to financial crisis multiples",
suggesting sentiment may be too pessimistic on some companies,
according to Tineke Frikkee, a fund manager at Smith &
Williamson who owns shares in Debenhams and M&S.
For brave investors, bargain-hunting in shares of
beaten-down retailers might just pay off.
In 1991, the last time shares of Next started the year with
a double-digit decline, they ended up more than 250 percent.
(Additional reporting by Tricia Wright and Alistair Smout;
Editing by Mark Trevelyan)