Stormy seas for retailers

Rapid changes, fickle consumers and high capital costs make retail a sector prone to distress and bankruptcies when recessionary conditions arise. And this time around looks no different.

For those that survived the disruption of the pandemic, or even thrived through quickly adapting to e-commerce and omnichannel selling, 2023 brought further uncertainty. While retail sales grew steadily, they still trailed the year-on-year (Y-o-Y) inflation trend. Interestingly, while essential items tended to ride the growth wave, sales of discretionary goods and big-ticket items remained depressed.

As pandemic support measures eased, inflation and economic uncertainty dampened consumer sentiment, with higher prices deterring discretionary purchases during the recent holiday season. This presented a further challenge for retailers in managing working capital and operational standards. Categories such as home decor and electronics, which had flourished during lockdown, lost momentum as people prioritized dining and leisure activities.

On the supply side, restricted capital availability, along with tightened fiscal measures, pressurized highly indebted retail firms causing a surge in bankruptcies, with North America witnessing several high-profile insolvencies. High post-Covid inventories have driven up operating costs and working capital requirements across the sector, calling for significant discounts to clear stock, reducing margins and hitting profits. Legacy retailers, along with niche startups and direct-to-consumer brands, were among the hardest hit.

The volatility (and resulting underperformance) in consumer markets sector is evident in our KPMG Financial Performance Index (FPI) score. The index, which bases the scores out of 100 (and wherein higher score indicates financial stability), reflected that the sector declined to a score of 93.91 in 4Q23 (3Q23: 94.49). Holiday season had an impact on regional sector performance, especially in North America and Africa region. Retail markets in Europe had a muted 4Q23 as the region continues to be face the brunt of geopolitical crisis. Other regions, South America and Asia witnessed a Q-o-Q decline in their respective FPI scores owing to macroeconomic headwinds. Singapore registered the steepest 9 percent Q-o-Q decline in sector performance, whereas Canada was on the opposite side of the growth spectrum (recording a 9 percent Q-o-Q growth).

The market ought to expect elevated default activity in the next 2 years, influenced by both liquidity shortages and refinancing risk as debt maturities approach. Retailers have upheld favorable liquidity profiles and financial flexibility, thanks to sufficient cash reserves, financial investments, and unsecured credit card receivables. Nevertheless, a substantial amount of debt is maturing in 2024 and 2025 and will require refinancing, causing repayment concerns.

• North America: According to a Reuters report, December saw a significant decline in the US retail sales, due to increasing interest rates, high inflation, and concerns about a slowing economy. In contrast, retail sales for September 2023 grew by 0.7 percent month-on-month (M-o-M), surpassing the expected figure of 0.3 percent. This fluctuation highlights the ever-changing nature of consumer spending habits, as demand for home, sporting goods, apparel, and electronics slowed in 2023. Consumer sentiment in Canada has been similarly hurt by high interest rates on top of high prices, and a sluggish 2023 is set to be followed by a slow recovery.
  
  
• South America: The economic slowdown in Latin America has forced retailers and e-commerce firms to adapt their logistics operations to remain competitive and profitable. Some of the regional economies (such as Argentina and Venezuela) are staring at hyperinflation (ending 2023 at 211.4 percent and 193.0 percent, respectively) – which is stifling retail sales. In Brazil, the El Nino weather phenomenon poses a short-term risk to retail trends; any hit to agricultural production is likely to fuel short-term inflation and curb consumer spending on goods and services.
  
  
• Europe: Growing consumer confidence has not translated into a rebound in retail sales. Spending on durable goods remains weak as households forego major purchases in the face of still-high energy costs in the winter of 2023-24. Festive season purchasing activity was muted across Europe, with UK spending on Christmas presents and festivities estimated to fall by around US$3.7 billion or 13 percent Y-o-Y in 2023. Supply chain disruption from shipping delays in the Red Sea and Suez Canal (one of the main routes for shipments from Asia to Europe as well as the US East Coast), is expected to impact retail market performance at least in the near-term.
  
  
• Asia: The retail sector is experiencing a resurgence in many Asian markets, with customers returning to stores during the holiday seasons. While e-commerce and digital platforms have become more popular in China and Southeast Asia, physical shopping is still an important part of the consumer experience. There are signs of recovery across various sectors, from apparel and accessories to home décor and furnishing.
  
  
• Middle East and Africa: Many Middle East economies have benefitted from long-term diversification into non-oil sectors. Saudi Arabia’s Vision 2030 includes measures to boost e-commerce, tourism and retail, while the government’s easing of foreign ownership restrictions has accelerated the sector’s development. African markets continue to be buffeted by macroeconomic headwinds, higher food prices and energy insecurity. With formal retailing largely underdeveloped, much of this region’s growth continues to be through locally owned hypermarkets and plazas.
  
  
• Oceania: The cost of housing plays a crucial role in shaping consumer sentiment in Australia. In the absence of real wage growth, high interest rates, along with significant property price increases, are expected to hold back household goods sector sales in the short term. Although retail turnover has increased more than anticipated, the underlying spending momentum has been lackluster. Inflation-adjusted sales have declined for three consecutive quarters and have not kept pace with population growth.

Better-performing sub-sectors include discount retailers, groceries, gasoline, and pharmacies, indicating that consumers are mainly spending on essentials. Inflation, high-interest rates, high consumer debt, depleted savings, and the resumption of student loan repayments later in the season may soon put the brakes on consumer activity.

Another key trend observed during FY23 was the strategic shift in the reaction to bankruptcies. The number of retailers opting for restructuring in bankruptcy, as a percentage of total bankruptcies, has dropped to 8 percent (in 2022 and 2021 it was 20 percent and 42 percent respectively). On the contrary, the percentage of liquidations and asset sales has increased. This prevailing trend can be explained by the fact that retailers have highly leveraged capital structure and liquidation/asset sales allows them to generate cash quickly, eliminate operational costs (such as rent, utilities and employee salaries), maximize recovery value of excess, obsolete, or underperforming merchandise and inventory, and avoid tedious legal complexities involved in restructuring route.

Throughout the pandemic, changes in consumer demand, and supply chain diversification, greatly impacted companies’ demand planning and inventory optimization. Streamlined supply chains based on just-in-time inventory and sales models came under strain and retailers are reconsidering what an optimal supply chain strategy looks like. 

After gaining massive popularity among consumers, especially during the pandemic, the Buy Now, Pay Later (BNPL) model is now under threat amidst worries about soaring consumer debt levels, as an increasing number of shoppers opt for payment plans for their daily expenses. Harsher economic conditions have exposed inherent weaknesses in BNPL businesses, with growing regulatory attention putting further strain on this business model. A closer look at industry leaders’ FPI scores suggests that these frailties have caused a significant slump in BNPL performance (particularly share price and market cap) since the peaks of 2021. For instance, share price of one of the leading BNPL firms in Asia Pacific recorded a significant ~90 percent decline since its peak in February 2021 citing market headwinds. Another global BNPL player registered a staggering 74.3 percent fall in the market capitalization during November 2021 and February 2024 period. Given this lower level of confidence in consumer finance segment, the upcoming years hold great significance for BNPL companies. During this time, they will likely strive to minimize expenses, boost earnings, and simultaneously sustain growth in transaction volumes and market presence. Failing to achieve these objectives could potentially lead established banks overtaking the market and displacing the majority of BNPL providers. To counter such challenges, the market has already started pivoting towards newer business models, such as ‘Save Now Buy Later’ (SNBL), aimed at high-value purchases.

Retailers’ embrace of AI has been several years in the making and predates the wave of excitement around generative AI in 2023. The uses of AI in a retail context are varied and include virtual assistants/chatbots, AR/VR and natural language processing. Gen AI is just the latest manifestation, one that can deliver even more prompt and personalized customer interactions and more efficiency in back office and administrative processes. AI is now synonymous with technology adoption and digital transformation. The most successful applications of AI have been improving cross-selling and up-selling and sustaining customer engagement – invaluable when inventory levels are bloated, and organizations are looking to enhance their customer’s experience.

Retailers are expected to keep on investing heavily in in-store technology, including self-checkouts, contactless card payments, and walk-out technology, to enhance the shopping experience and mitigate labor shortages. Although these advances have boosted customer traffic in stores, they have also increased operating costs (primarily rent costs due to expansion of store sizes).

While these factors are some potentially significant revenue drivers, financial performance will continue to rest on effective management of cost drivers. The fact remains that the biggest costs for many businesses are leases and people. In such a competitive environment, organizations struggling with financial performance will continue to realize more tangible relief to bottom lines through layoffs, store closures and factory shutdowns.