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European Retailers Seek To Reopen Their Doors To Usher In The Post-Pandemic Recovery

Buoyant e-commerce and the reopening of nonessential stores have boosted retail sales on the back of higher volumes. Furlough and state-support schemes have helped augment household savings, as have lower spending on travel and out-of-home leisure activities. The Consumer Confidence Index has increased in recent months, both for the eurozone and the U.K., having been at low levels since March 2020, signalling a boost in consumers' confidence toward the economic situation over the next 12 months.

Chart 1


The recovery in retail sales, which started in the second half of last year, has continued into this year, with the overall retail sales value index in the first four months of 2021 remaining higher than before the pandemic. Still, meaningful differences exist between subsectors. For instance, the apparel sector is showing signs of a gradual recovery thanks to stores reopening and higher demand as pandemic restrictions are loosened. Yet apparel sales remain well below pre-pandemic levels and we do not expect the segment to fully recover its toplines before 2022. At the same time, it is likely that consumers will reallocate their spending from food and home-centric purchases to travel and leisure activities. While strong pent-up demand augers well for restaurants, pubs, and cafes, we will likely see an exceptionally high demand for grocery, home improvement, and specialty to moderate. These shifting customer demand and spending patterns will also add to the variability in sales across subsectors during the recovery phase.

We believe that the expectations of economic recovery, vaccination rollouts, and the release of pent-up demand following the reopening of nonessential stores will support a recovery in retailers' toplines in 2022. However, we also foresee the recovery as being uneven and fraught with risk. About 40% of rated European retailers still have negative outlooks or are on CreditWatch with negative implications, and 17% are still in the 'CCC' rating category, indicating significant vulnerability to tough business or financial conditions. Many of these retailers will struggle to capitalize on the post-pandemic recovery due to strong competition, limited capital to invest in digital transformation, and high leverage.

When The Going Got Tough, A Focus On Cash Helped Limit The Damage

In the main, the European retail sector held up well despite the enforced store closures and operating restrictions. Most retailers took defensive steps to lower their cost base, helped by government support in the form of furlough grants and other measures such as business rate and payment holidays. Rent negotiations yielded varying outcomes, ranging from cuts to cancellations or deferrals, but nevertheless helped retailers reduce cash outflows during periods of store closures.

For many rated retailers, working capital was also an element of positive surprise as retailers had payback from their efforts to carefully manage order flow, inventories, and payment terms. Larger retailers with stronger e-commerce and distribution networks were able to capitalize on their bargaining power with suppliers to generate strong cash flows on the back of working capital. This went hand in hand with proactive refinancing, while cuts to capital expenditure and shareholder returns also supported cash flow and liquidity. In fact, most listed nonfood retailers cut or cancelled their dividends and share buybacks.

On average, S&P Global Ratings-adjusted debt at investment- and speculative-grade food retailers and at investment-grade nonfood retailers fell in 2020 compared to 2019. Adjusted debt at speculative-grade nonfood retailers and restaurants increased, but this increase was still moderate in view of the lack of credit we give for cash in our adjusted debt calculation for many companies rated in the 'B' category and below, and the enormous disruption to their businesses from the pandemic.

Chart 2


Price Competition Will Remain High As Inflation Should Be Transitory

Higher input and commodity prices have not affected retail sales significantly, as volumes more than prices have driven higher sales. We believe that the recent jump in inflation will mainly be transitory and partly due to the base effect from a comparison with depressed prices last year, as well as to the near-term boost to prices from supply and labor bottlenecks as order levels and restocking activity catches up with higher demand following stores reopening.

However, retailers' ability to pass on input-cost increases to customers varies because of the uneven recovery across the sector. Larger and more-diversified retailers have greater pricing flexibility thanks to more nimble and well-established supply chains. For others, especially smaller and highly leveraged retailers, their ability to absorb higher input and labor costs remains limited, and the effects of the pandemic and worries about inflation will force them to implement better processes and systems to become more competitive. Concerns about higher input prices and the need to manage margins will curtail promotional activity in the sector and narrow the price gap between discounters and mainstream retailers.

Retailers With Well-Developed Omni-Channel Models Will Have A Competitive Advantage

E-commerce has been the mainstay of most nonessential retailers since the onset of the pandemic, and strong e-commerce growth partly limited the damage from store closures. Store closures and stay-at-home orders created the perfect conditions for a rapid acceleration of e-commerce, making it a focus for retailers and their main earnings driver during lockdowns. Even though food retailers were allowed to keep their stores open, they also benefitted from the surge in e-commerce as many customers moved to buying their groceries online.

Worldwide, retail e-commerce sales grew 27.6% in 2020, according to estimates. In our view, while this high growth rate will slow as brick and mortar stores reopen, e-commerce will remain the major competitive differentiator between retailers. Retailers that have a well-invested e-commerce proposition and a nimble omnichannel sales model will have a wider customer reach and a stronger competitive advantage compared to smaller and more localized store-based retailers who did not invest sufficiently in the transition to digital commerce. Retailers without strong e-commerce capabilities have struggled to keep pace with changing demand and provide a customer experience that can compete with the reach, range, speed, and efficiency of a well-developed e-commerce platform. While the brick and mortar store will retain its importance, we expect retailers to become more selective in the nature and number of store sites and be less tolerant of loss-making locations.

Chart 3


Many Retailers Have Put The Worst Of The Pandemic Behind Them…

Many rated retailers reported better operating performance than we expected in 2020, thanks to the steps they took to reduce costs and conserve cash, along with strong e-commerce and resilient home consumption. An improving vaccination outlook and expectations of economic recovery, together with the reopening of physical stores and pent-up demand, led us to take nearly 30 positive rating actions over the past 12 months, mostly in the nonfood segment. However, this segment also had the greatest number of negative rating actions in 2020, which shows that the fortunes of some non-food retailers are gradually turning a corner following the cataclysmic effects of the COVID-19 pandemic.

Chart 4


…But The Risks Remain Significant For Some

The total number of negative rating actions since the onset of the pandemic exceeds positive rating actions by more than one-third. This indicates a marked deterioration in the creditworthiness of a section of smaller and highly leveraged retailers, and it will take a sustained period of strong trading to reverse this deterioration, if it is possible at all. Solvency risks remain acute for these issuers.

About 40% of the European retailers we rate have negative outlooks or are on CreditWatch with negative implications. Despite 9% of the rated retail portfolio defaulting since the onset of the pandemic, 17% of ratings are still in the 'CCC' category, indicating these retailers' significant vulnerability to tough business or financial conditions. These retailers will struggle to capitalize on the post-pandemic recovery due to strong competition, limited capital to invest in digital transformation, and high pre-COVID-19 leverage that the pandemic has only exacerbated.

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Raam Ratnam, CFA, CPA, London + 44 20 7176 7462;
Secondary Contacts:Mickael Vidal, Paris + 33 14 420 6658;
Abigail Klimovich, CFA, London + 44 20 7176 3554;
Research Contributor:Bhushan Zalavadiya, Pune;

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