The good news for retailers as they head into the holiday season is that demand remains strong among consumers, who are ramping up spending that had been on hold for a long time.
That’s according to R.J. Allan, head of retail corporate banking at global finance group MUFG.and Ed Gately, head of asset-based finance, investment banking, at the firm. But retailers are also facing new pressures in 2021, warn Allan and Gately, and the jury is still out on whether consumer demand will be able to offset the cost of the pressures that retailers are trying to manage.
Here are their insights on the state of retail heading into the holidays — and beyond.
1.A toss-up between competing forces and their effect on top-line revenues and margins
Most retailers have been reporting strong earnings throughout the year, and we foresee the continuation of their healthy financial performance through year-end. All the same, we’re witnessing a battle between opposing forces whose effect on top-line revenues and margins will be registered more decisively after the holiday season.
On one hand of the ledger there’s strong consumer demand—a tailwind for retailers across the board—only to be confronted with three spoilers: supply-chain disruptions, inflation and rising wages.
Manufacturers and distributors continue to be overwhelmed by the unleashing of pent-up demand and subsequent surge in orders, by worker shortages, and by a lack of key components and raw materials. These simultaneous factors are curtailing their pre-pandemic capacity to produce and supply goods and, consequently, crimping retailers’ inventories.
In some cases, dwindling inventories could result in retailers not being able to maximize their top-line revenue again this holiday season given less merchandise to sell. We expect many retailers to continue experiencing high sell-through rates, but the impact on margins will be important to monitor and determine which retailers are best able to leverage strong demand in order to pass these costs on to the consumer.
Although retailers are working to get ahead of supply-chain disruptions, we do not believe inventories will keep up with demand—especially given the large number of consumers who are expected to do their holiday shopping well in advance, knowing they could face shortages later on.
2. Retailers see an improvement in credit and less borrowing
Retailers’ credit profiles continue to improve with their financial performance, which in many cases has beaten estimates. In fact, over the past year, we’ve seen credit profiles across the retail sector on a positive trajectory—one that we expect will continue throughout the holiday season.
Financing conditions remain healthy in the retail loan markets for both banks and institutional investors. Retailers are borrowing less, with high levels of cash on their balance sheets, strong sales performance, and lower working capital needs. Loan outstandings (the amount of loans that haven’t been fully repaid) are therefore down substantially year-over-year.
3.Asset-based finance remains an attractive solution for retailers in search of liquidity
Many retailers resorted to asset-based finance (ABF) at the onset of the pandemic when their cash flows were squeezed—and when pledging inventory was the most efficient way for them to gain access to liquidity. With the improvement in earnings, we’ve seen some revert back to cash flow-based finance, yet ABF remains an effective financing method for those who wish to monetize assets (such as accounts receivable) and take advantage of inventory appraisals that usually run higher than their cost value for branded retail. If the positive trajectory of credit profiles continues, we could see more ABF deals revert to cash flow-based financing in 2022.
4. Brick-and-mortar is here to stay—yet retailers are getting creative
A preponderance of retail purchasing continues to take place in physical stores, but we believe that retailers who bolster their omni-channel capabilities to offer a seamless consumer experience will be best positioned to remain competitive.
For example, many brick-and-mortar outfits already field online orders, yet almost all of them now pair that capability with dedicated in-store and curbside pick-up locations as a consequence of the pandemic. Others are experimenting with their physical footprint through pop-up stores (also known as “flash retailing”) by opening short-term sales spaces in various locations for days or weeks on a flexible and opportunistic basis, whether to capitalize on a scheduled event somewhere or to take advantage of a local fad.
Some retailers also offer in-store amenities such as advanced technology, exclusive events, unique brand collaborations, and highly knowledgeable staff to create memorable in-store experiences that foster brand loyalty. We expect these trends to continue.
As an upshot of the pandemic to support the important brick-and-mortar part of the equation, many retailers are benefiting from having renegotiated their rents lower with their landlords, which give them more flexibility going forward.
5. Supplier financing is helping retailers
In certain cases, excess demand for goods has overburdened suppliers' production capacity and placed pressure on their working capital, while physical disruptions in the manufacturing or delivery of goods have triggered delayed payments.
Since cash-starved suppliers cannot always afford to wait the full payment terms set with their retailers, some retailers have established supply chain finance programs with their suppliers (also known as buyer-led programs). Banks have been able to provide two distinct benefits in these cases: supporting suppliers with quicker access to cash on their accounts-receivable balances, and helping retailers enhance their working-capital cycle.
In this manner, retailers have enabled suppliers to remain solvent and efficient producers while reducing potential disruptions to their own operations.
In all, we view the retail sector as strong from a fundamental and financing perspective ahead of the big holiday season, though supply-chain disruptions, inflation and inventory shortages will continue to challenge the sector over the short and medium term.
Looking ahead, retailers will need to continue innovating and experimenting with new ideas and technologies while strengthening their omni-channel capabilities to remain competitive.