High Inflation Halts Europe’s Post-Covid Retail Recovery

The post-pandemic recovery of European retailers’ profitability and deleveraging have been halted by sharply increased inflation that is forcing consumers to ration purchases and raising retailers’ costs, some of which can be difficult to pass on, Fitch Ratings says. Many of these retailers’ ratings in our portfolio are on Negative Outlooks, particularly in speculative grade, reflecting the pressures. However, our base case projections assume the successful completion of certain mitigation measures that are already underway, which, in the medium term, will help most retailers return their leverage metrics to make them consistent with their ratings.

Changing spending habits have affected European retailer revenues. Sales volumes have fallen as consumers now look to buy fewer items and cut discretionary spending. Furthermore, as customers trade down, the sales mix shifts towards cheaper products, with some ‘value’ retailers that focus on the lowest price ranges losing customers to food banks. These negative trends are only partially offset by the decline in eating out and an increasing reliance on packed lunches that force customers to buy more from retailers.

Although European retailers have been increasing their prices to pass on wholesale price growth, this is gradual, with increases differentiated by product price points to retain customers. Such measured increases are likely to continue into 2023. Retailers are also concentrating on deals and promotions to protect their market shares and maintain footfall in their stores. Retailers operating in countries with intense competition, such as the UK, typically demonstrate weaker profitability trends in these conditions as they are forced to raise prices more slowly or increase promotions more aggressively.

Apart from increased wholesale product prices, retailers face large increases in their operating costs, including energy and personnel expenses, which may be harder to pass onto customers, adding to margin pressures in 2023. Retailers, particularly in the UK, often hedge energy costs for the coming six-to-twelve months, but rapid price rises will eventually increase retailers’ cost bases, despite government support programmes rolled out or planned in many European countries. Some retailers may now be seeking longer term energy hedges to ensure greater visibility over their profit margins. In addition, nearly full employment in many developed markets has spurred higher labour expenditure.

High inflation has intensified discussions between retailers and suppliers over payment terms and may force the former to increase the use of supply-chain finance and tighten working capital management. Weaker retailers may also try to renegotiate rents with smaller property freeholders, especially in less favoured or affluent destinations. Retailers’ lease payments, particularly in the UK, are not automatically increased in line with inflation unless property portfolios are securitised against debt, as is the case with some of Sainsbury’s and other supermarkets’ sale and leaseback financings, where payments are increased by the Retail Price Index (although with a cap).

We expect the profitability of most Fitch-rated retailers in Europe to shrink in the near term, stalling a post-pandemic recovery. This is sensitive for the credit profiles of issuers operating in low-margin sectors, such as retail. Risks of further deterioration in leverage metrics are reflected in multiple Negative Outlooks on EMEA retailer ratings. Together with weaker-than-expected free cashflow generation, such deterioration may lead to further negative rating actions in 2023.
Source: Fitch Ratings