MARKET COMMENT
Retailers Under Threat From Tesco

By David Kuo (TMFDragon)
December 18, 2003

According to a recent research by Switch, Britons are expected to spend an average of £868 each on Christmas this year. On the surface that may seem like an extraordinary amount of money to spend but it is only £6 more, or a modest 0.7% increase, on our Crimble-spend last year.

The survey was carried out before the quarter-point hike in interest rates in November though. That could suggest consumers may prove to be more cautious when the tills are cashed up this Christmas.

Shopkeepers are already finding that Christmas sales are falling short of expectations - it could even be one the worst Christmases for some retailers for years. Over the past four or five years, retailers have been able to count on Christmas trading to give annual revenues a welcome boost. After all, trading in the run up to Christmas can account for as much as 60% of annual sales.

However, a downbeat trading statement by Matalan (LSE: MTN) last week has flagged up concerns that all may not be well on the high street. The discount retailer said total sales in the 14 weeks to 6 December grew by a paltry 2.4%, and like-for-like sales fell a whopping 7%.

Matalan's woes could be company-specific. The company's primary objective is to offer goods, predominantly clothing, at attractive prices. Its competitive advantage has been achieved through a low-cost structure that includes siting its stores in cheaper out-of-town locations.

However, cost leadership can only be effective if a company can use it to provide an insuperable barrier to entry through economies of scale. Clearly dwindling sales growth at Matalan would suggest that its barriers to entry are not entirely insurmountable.

Matalan's greatest threat is likely to come from the supermarkets, which can comfortably achieve greater economies of scale for almost any product they choose to sell because of their much wider geographic presence and the frequent visits that consumers make to their local grocer.

In particular, a quick wander around any Tesco (LSE: TSCO) superstore will easily explain why the supermarket now commands a 4.4% share of UK clothing market. Tesco recently reported that clothing sales rose 34%! That must be a worry for other discounters such as Brown & Jackson (LSE: BRJK), the owner of Poundstretcher, and Associated British Food's (LSE: ABF) Primark.

Tesco's non-food offerings are unlikely to stop at clothing. It has already ventured into CD, DVD and video sales, which is a concern for the likes of HMV (LSE: HMV) and Woolworths (LSE: WLW). It has also moved into books, albeit in a limited way, which cannot augur well for WH Smith (LSE: SMWH) and Ottakar's (LSE: OKR). And it can only be a question of time before Tesco sets its sight on Dixon's (LSE: DXNS) and Kesa Electricals' (LSE: KESA) market share.  

Tesco is expected to deliver profits of £1.6b this year on sales of £31b. Earnings per share of 15.9p have been pencilled in. This values the company, whose shares trade at 247p, at 16 times prospective profits. Despite the fact it's terrorising the rest of the high street, that looks about right for now.