UK General Retailers
21 February 2008 UK GENERAL RETAILERS
It
322
We’ve only just begun
The de-rating of the Retailers since April 2007 has been severe and,
with rates already falling, valuations are tempting. However, we
doubt that we have seen the worst of the current slowdown and still
view earnings risks as material. We therefore remain Underweight,
favouring stocks with low operational and financial gearing.

The key question is a macro one
In non-food markets, LFL sales were negative in November and December. However, we
doubt we have seen the worst of the slowdown or the end of the downgrades. So far,
trading has not been as bad as in 2005, yet now we have more perceptible signs of a
housing market reversal, tighter consumer lending criteria and the possibility of a marked
rise in unemployment. The big risk is that this is a sharper and more protracted slowdown
than in 2005, with falling sector earnings in both 2008 and 2009.
Is it discounted?
The key uncertainty is how bad the current slowdown will be and how severe the squeeze
on earnings might be. We have taken this opportunity to review our 2008/09 estimates and
make a number of downward revisions. The result is an aggregate sales and profit
performance that is worse than that seen in 2005. Despite this we believe estimates remain
at risk of further downgrades, particularly if the current slowdown is a protracted affair and
2009 earnings also fall. Most of our numbers assume a recovery in that year and if this has
to be reversed, the resulting downgrades would be very material. We therefore remain wary
of the bigger-ticket and highly operationally or financially geared end of the sector.
There are also some upside risks
We do see scope for a re-rating of retail earnings as and when markets start to look
through the current downturn or when credit markets start to work more effectively. In our
view, these themes will carry more weight by the end of 2008 than they do now. However,
given the downgrade risks, our preference remains for the less operationally and financially
leveraged end of the sector. This is not where the genuine value situations lie, but it is the
risk-averse way of covering a potential re-rating of retail earnings.

Stock conclusions
We still favour stocks with low operational and financial gearing and have positive views on
Topps Tiles, N Brown, Ted Baker and Dunelm. The internet remains a key differentiator of
performance and we recommend avoiding stocks menaced by the web such as Kesa, DSG and
Game, but are positive on stocks where the internet will be a major growth driver – most notably
ASOS and N Brown. Weak demand and adverse currency movements make us more cautious on
clothing stocks and we downgrade M&S and Debenhams to Reduce and NEXT to Hold.

Contents
Summary and conclusions 3
A severe de-rating 3
How bad will the slowdown be? 3
Estimate risks: still a big issue 3
Valuation risks on the upside: an issue for later in 2008 3
The internet: still a dynamic driver of stock performance 4
Stock conclusions 4
Forecast changes and ongoing risks 6
Earnings risk and operational gearing 8
The web dynamic 9
The macro outlook and retail profitability 11
Background 11
2005: a reminder 11
What is different this time around? 12
The housing market 14
Unemployment 16
Interest rates 16
Valuation 18
A severe de-rating 18
The 2005 comparison – bid premia vanish 19
The upside risks to valuation 19
Conclusions 20
Home Retail Group 25
Kingfisher plc 26
Marks & Spencer 27
NEXT 28
Carpetright 29
DSG International 30
Debenhams 31
Game Group 32
Halfords Group 33
HMV 34
JJB Sports 35
KESA Electricals 36
N Brown 37
WH Smith 38
ASOS Plc 39
Blacks Leisure 40
Dunelm 41
Flying Brands 42
Mothercare 43
Smallbone 44
Ted Baker 45
Topps Tiles 46
Woolworths 47
Disclosures 49