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Tread Carefully in the Retail Sector

Retail stocks have not reached bottom yet, with worse times seemingly ahead after Britain's biggest retailer reported slowing sales in its core market, analysts said.

Sales at Tesco's British stores open more than a year rose 3.1 percent in the six weeks to January 5, below the 4 percent analysts had expected and losing Christmas momentum. They were also lower than third-quarter growth of 4.1 percent.

The drop in growth outlines the woes of a sector hit by consumer prudence in the face of rising utility and food bills and with fears of a U.S. recession -- possibly spilling to other parts of the world -- looming.

"Some stocks got oversold, but … there's still a danger they could fall further," Nick Bubb, retail analyst at Pali International, told CNBC.com. "I think overall it's right to be underweight in the sector."

In early trading, Tesco shares lost 4 percent, but pared some of the losses later, to trade 2 percent lower at midday, compared with a fall of 2.3 percent for the retail sector overall.

Fearful Consumers

Last week, the biggest British clothing retailer, Marks & Spencer, delivered an unpleasant surprise to the market when it said sales at shops in Britain open more than a year fell 2.2 percent during the key Christmas period, despite the fact that it had slashed prices to lure shoppers spooked by the credit crunch.

Analysts had expected sales to remain flat and Marks & Spencer shares fell more than 20 percent last Wednesday after the announcement was made.

British department store group Debenhams and fashion retailer Next, whose shares lost 10 percent and 7 percent respectively that day, were among the collateral victims of Marks & Spencer's announcements.

But on Tuesday, Debenhams reported a rise in Christmas sales, bucking the gloomy trend, helped by strong sales of designer clothes and online sales growth.

Debenhams shares leapt nearly 13 percent on Monday, after the Sunday Times reported that it enjoyed a better-than-anticipated Christmas. Its sales at stores open more than one year rose 2.2 percent in the four weeks to January 5, while most analysts had expected them to fall slightly.

But the department store, which runs 136 outlets in the UK and Ireland, warned that conditions were tough and it might have to continue to cut prices if competition intensifies.

"It will be a tough year, it will sort out the winners from the losers," Bubb said.

Easier Ride for Food

Food retailers are likely to have an easier ride than non-food retailers, he predicted, as the impact of rate cuts from the Bank of England on consumption has yet to be felt.

British retailers' fight for market share has intensified, with fourth-largest supermarket Morrison improving its market share to 11.4 percent from 11 percent a year earlier, the highest growth rate since it took over Safeway in 2004.

Exposure to emerging markets, where booming economies and rising salaries have sent consumers flocking to supermarkets, has acted as a cushion for some retailers.

Top German retailer Metro -- also the fourth largest globally -- boosted hopes for the sector last week when it posted an 8.3 percent increase in sales over the Christmas quarter. Around 40 percent of Metro's revenues come from abroad.

Tesco's international business also rose nearly 30 percent in the 12 countries outside the UK where it operates, with the strongest growth in Malaysia, Turkey and Central Europe.