Christmas will come early to the high street

HIGH-STREET retailers have every reason to be cautious right now. If it isn’t the government squeezing households’ disposable incomes with one hand and hiking VAT with the other, then surges in the prices of commodities such as cotton, which is at a 15-year high, are threatening margins.

Only last month Next chief executive Simon Wolfson said that clothing prices may have to rise by as much as 8 per cent in 2011. With consumers still lacking the confidence or the money to shop until they drop, retailers are understandably loath to pass on higher input costs. But after two years of heavy discounting to keep the tills ringing and tinkering with the supply chain, they may have little room for manoeuvre left and be forced to pass on higher prices to the consumer.

However, this is a familiar story and therefore likely to have already been priced in. Consequently, any caution from chief executives during earnings season – which kicks off in earnest on 18 October in the UK and Europe – is unlikely to have a significant downward effect on retailers’ share prices. And any better-than-expected news will give stocks a sharp boost.

One analyst who is expecting a less gloomy winter for the high street is Arden International’s Nick Bubb: “The gloomsters still expect the coming storm of public sector austerity to decimate the consumer but the resilience of non-food trading is striking and September is a much more important month than August so it can’t be shrugged off.” He also believes that the “lowly sub-10 times price-to-earnings (p/e) valuations in the general retail sector look pretty attractive”.

Longer-term investors who think retailers’ share prices have been overly depressed by the gloomy outlook can use both exchange-traded funds (ETF) and covered warrants to take a bullish perspective.
Covered warrants allow you to take a view about where you think large cap retailers such as Marks & Spencer and Next will be by the end of the year. For example, Societe Generale has a call warrant (where you bet that the share price will rise) with a strike price of 400p and an expiry date of 17 December 2010. Provided that the stock rises to above 400p before this date, your position is “in-the-money” – ie, in profit.

ETFs are more transparent and diversified so they protect from the risks of investing in a single stock but you can’t invest in only the British retail sector. Through providers such as BlackRock’s iShares you can buy an ETF of the STOXX Europe 600 Retail index. This includes
both food and non-food stocks and the biggest holding is Tesco at 21.62 per cent. The second is Stockholm-listed Hennes & Mauritz (H&M) with 13.62 per cent.

With the sector and many of the constituent stocks attractively priced on a p/e basis, a bullish outlook for the retail sector could prove lucrative. Christmas might have already hit the high street but retailers could well experience a Santa rally over the next few months.,