A Deep Dive into the Retail Industry

The retail industry has always been vibrant, but of late, it has been under tremendous pressure from the emergence of e-commerce and online shopping.

Many of the retail stalwarts in Asia, Europe and the USA are suffering from declining sales, weak demand and high expenses in a world where more and more people shop online and shun brick and mortar stores.

Analysing the retail sector has never been easy even during good times, as there are many aspects to look into and measure. Of course, during the current age of disruption, it becomes even tougher to tell which retailer could survive and which one may go under.

Let’s look at some characteristics of retailers and some financial and operational metrics which the industry uses.

Financial Metrics – Margins And Cash Conversion

When it comes to financial metrics, a common one used is the gross profit margin, as this measures how much the retailer is paying its suppliers to stock their goods on the retailer’s shelves to be resold to customers.

Gross margin can be compared across different retailers in different countries to assess their bargaining power against their suppliers. Higher gross margins would imply a stronger store presence or distribution network, hence enabling the retailer to negotiate for bulk discounts which then drives down the cost of goods. Pricing is fairly consistent across the industry as most products are similar across a spectrum of retailers. Therefore, it is difficult to get an edge in terms of preferential pricing.

Cash conversion is another important financial metric as retailers may end up stocking their shelves for long periods without making a sale, hence cash conversion may be poor for such retailers. As most sales are cash-based while the payment of suppliers is based on credit terms, retailers often have an advantage in that they receive cash upfront which they can then retain to pay suppliers much later. The main wild card is thus how fast their inventory can be sold and converted to cash.

Operational Metrics – Stores And Growth

For operational metrics, investors should look for same-store-sales growth (SSSG), as this measures the sales per store on a year-on-year basis and defines the retailer’s organic sales growth on a per store basis. Positive SSSG would, of course, be a plus as it implies more shoppers are visiting the same store over time.

Another metric to look at is the store count and sales per store or employee. Store counts would measure the number of stores opened or closed during the year and is a reflection of a retailer’s expansion or downsizing efforts. Sales per store or employee is a measure of sales efficiency and is a metric which can be compared across different retailers.

How To Value Retailers

Due to the cash flow stability of the retail business, and the fact that most of their sales are in cash (as opposed to credit sales in most other industries), analysts often use a discounted cash flow model to estimate the fair value of a retailer.

A short-cut method which investors can use is the price to free cash flow (P/FCF) metric as most retailers generate copious amounts of free cash flow unless they are expanding their store counts aggressively.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.