Five retail stocks set to thrive

Our City expert on the UK shares tipped to shine despite the gloomy economic backdrop.

UK retail is facing pressures not seen for a generation, but this storm hasn’t stopped a City bank from naming five stocks worthy of “buy” recommendations.

Today’s deep-dive note from Bank of America rates FTSE 250-listed Watches of Switzerland (LSE:WOSG) and Dr Martens (LSE:DOCS) as top picks, while also seeing potential upsides for shares in JD Sports Fashion (LSE:JD.), WH Smith (LSE:SMWH) and heavily sold Hut Group business THG (LSE:THG).

However, blue-chip retailer Next (LSE:NXT) loses its “buy” recommendation and the bank has placed ASOS (LSE:ASC) and Primark owner Associated British Foods (LSE:ABF) at underperform due to their fast-fashion focus being most at risk from UK consumer real income pressures.

Marks & Spencer (LSE:MKS), whose shares have reversed from 250p at the start of the year, has a neutral rating and price target of 185p. The shares stood at 148.4p this afternoon, having lost another 10p as UK retail sentiment continues to be chilled by the uncertain outlook.

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The biggest cloud is energy inflation after a 54% jump in the Ofgem price cap, while budgets are also being squeezed by national insurance hikes and cuts to Universal Credit.

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At a time of restricted pricing power, retailers also face significant supply chain inflation. A spot check of key raw materials by Bank of America shows a 24% year-on-year rise, fuelled by key fibres such as cotton at 85% higher and polyester up 15%.

Consumption has been robust so far, possibly aided by some drawdown of savings and government support measures. But the fear that households will soon choose to reprioritise budgets away from discretionary items such as clothing and footwear means an uncertain outlook for the likes of AB Foods and ASOS.

These conditions are less likely to impact companies in the luxury sector, travel retail or those in premium footwear where there’s greater pricing power.

In luxury goods, Rolex retailer Watches of Switzerland is favoured as Bank of America notes that more than 50% of luxury watch buyers in the UK sit within the top 5% of the population by income group.

Shares were among the best performing in the FTSE 250 last year, but have declined by almost a quarter so far this year. They have rallied in the past month to 1,126p after hitting a six-month low at the start of March, but Bank of America believes a price of 1,500p is merited.

It adds that Dr Martens is also on a firmer footing as the bank estimates that more than 50% of its consumers are in the top-third of the UK population by income group.

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High gross margins and strong pricing power, as well as the company’s greater geographic diversification, also drive a target price of 400p compared with today’s 228p.

WH Smith’s buy recommendation reflects the fact that travel retail benefits from a captive customer. It said: “Even with inflation, it will still be significantly cheaper to buy food at WH Smith than it is to eat in a restaurant or buy food on the plane.

“Likewise, for magazines or souvenirs, these purchases are made for immediate consumption or as a last-minute choice. We therefore do not expect significant price elasticity for WH Smith products.”

It has a price target of 1,900p, which compares with today's 1,447.5p as one of this year’s more resilient retail sector performers. JD Sports is down by a third in 2022 but Bank of America believes there’s scope for shares to recover from today’s 146.5p to 250p.

The bank said: “Unlike general apparel, we believe that premium footwear companies should be able to increase prices. This is due to the importance of brand in this segment, which increases customer loyalty and lowers price sensitivity.”