UK Apparel Malaise Signals a Shift in Consumer Spending Priorities

UK Apparel Malaise Signals a Shift in Consumer Spending Priorities Sales of clothing and footwear in the UK have fallen in four of the last six months, according to data from the Office for National Statistics (ONS). Clothing and footwear specialists sales have fallen even more sharply; they were down 7.5% year over year in April and down 0.7% in May. The squeeze in retail seems to be much less about consumer caution with regard to spending or worries about the Brexit referendum, and much more about consumers wanting to spend on experiences rather than on products. Given previous years patterns, we expect the apparel category to see a period of lower but positive growth over the medium term. 1

Executive Summary Sales of clothing and footwear in the UK have fallen in four of the last six months, according to data from the Office for National Statistics (ONS). In April 2016, sales fell by fully 4.0% year over year, the category s deepest decline in four years and its seconddeepest decline since 2009, when the economy was still suffering from the downturn. In May, the category bounced back to 4.1% year-over-year growth. Clothing and footwear specialists sales have fallen even more sharply; they were down 7.5% year over year in April and down 0.7% in May. The gap between growth in the total apparel category and growth in the specialists sector is widening, implying that Internet pure plays such as ASOS and boohoo.com are accelerating their market-share gains. It is unclear if May s positive apparel category growth will be maintained, but the record from recent years suggests that a sustained, month-after-month decline would be highly unusual. Even amid the depths of the 2008 2009 downturn, sales declines were interspersed with uplifts. Consumer spending data show that growth in clothing and footwear sales slowed through 2015, following a period of strong growth that began in 2013. The current apparel slowdown began roughly three years after the last softening in the market, which occurred roughly three years after the previous low point, seen during the 2009 economic downturn. An unseasonably warm autumn in 2015 concealed the underlying slowdown in apparel sales. What appeared to be a temporary, weather-driven softness now looks to have been the start of a period of deceleration. But consumers are still spending. The squeeze in retail seems to be much less about consumer caution with regard to spending or worries about the Brexit referendum, and much more about consumers wanting to spend on experiences rather than on products. We think the real story behind the apparel slowdown is the shift in consumer spending from retail to services. The US has seen this trend play out for some time, with shoppers spending on dining out, in particular, while taking a more cautious attitude toward retail, including apparel. The trend is now becoming entrenched in the UK, too. We think social media such as Instagram could be fueling the trend of consumers spending on services rather than on things. As consumers document ever more details of their lives online, they face increased pressure to be seen doing interesting and fun stuff. We call this the Instagram effect. Given previous years patterns, we expect the apparel category to see a period of lower but positive growth over the medium term. 2

Even during the economic downturn, we did not see sustained negative growth in sales of clothing and footwear. What Has Happened? Sales of clothing and footwear have fallen in four of the last six months, according to data from the ONS: A weak autumn in 2015 turned into a poor Christmas, with sales of clothing and footwear falling by 2.3% in December. After a bounce in January, category sales fell again, by 0.4% in February and by 1.5% in March. In April, clothing and footwear sales slumped by 4.0%, the category s second-worst postrecession decline only a fall of 4.9%, seen in 2012, was worse. In May, category sales growth recovered, increasing to 4.1%. The graph below puts the recent decline in context: although we saw deeper drops in 2008, 2009 and 2012, those were sporadic, one-month plunges. Even during the downturn, we did not see sustained negative growth in sales of clothing and footwear. The recent sporadic increases in category sales are in line with these historical patterns. It is worth noting that, although they constitute the best short-term measure available, the monthly data we rely on are based on a relatively small sample of only 31 major retailers. Figure 1. UK Sales of Clothing and Footwear, by Month: YoY % Change 15.0 10.0 5.0 0.0 Period Average (5.0) Postrecession Low Point (4.0)% (10.0) 08 09 10 11 12 13 14 15 16 All data in this report are nonseasonally adjusted. Monthly data for clothing and footwear sales are based on a sample of 31 major retailers out of the ONS sample of 900 major retailers. Source: ONS Retail Sales Index/Fung Global Retail & Technology While category sales recovered in May, as we show later, sales at clothing specialists continued to fall. 3

History suggests that a sustained, month-after-month decline in sales of clothing and footwear would be highly unusual. The recent apparel slowdown began roughly three years after the last softening in the market, which itself came roughly three years after the preceding low point, during the economic downturn. Will Declines Return? The latest data, covering May, show a recovery in the apparel category but will this be short-lived? History suggests that a sustained, month-aftermonth decline in clothing and footwear sales would be highly unusual. Even amid the depths of the 2008 2009 downturn, sales declines were interspersed with uplifts. So, the negative growth trend is unlikely to persist: in the midterm, tepid positive growth is more likely. Our outlook assumes that Britain votes to remain in the EU when the Brexit referendum is held on June 23 an outcome that previously looked relatively certain, but that has recently become much less so. If the country votes to leave the EU, the resultant uncertainty could dampen discretionary spending in the near term. The downturn in apparel spending is borne out by the core quarterly spending data from the ONS, which are based on a broader range of sources than the monthly figures. These data show that growth in the category slowed across 2015 following a period of very strong growth. (Data for the fourth quarter of 2015 are the latest currently available.) The recent apparel slowdown began roughly three years after the last softening in the market, which occurred roughly three years after the previous low point seen during the 2009 economic downturn. The pattern of the previous cycles suggests that a brief fall in category spending is likely to be followed swiftly by a gradual improvement in growth rates. Figure 2. UK Consumer Spending on Clothing, Accessories and Footwear, by Quarter: YoY % Change 13 11 9 7 5 3 1 6.6 5.9 3.8 4.3 1.5 0.8 4.0 5.9 2.6 8.1 8.38.6 7.7 3.3 2.7 2.1 1.6 5.0 10.7 4.9 12.8 8.4 4.1 9.5 5.1 3.8 3.0 (1) (3) (0.2) (0.2) (1.5) (1.5) (2.0) 2008 2009 2010 2011 2012 2013 2014 2015 Source: ONS Consumer Trends/Fung Global Retail & Technology 4

The Specialists Sector Bears the Brunt of the Decline The decline in apparel demand is amplified among the clothing and footwear specialist retailers, which saw their sales fall by fully 7.5% year over year in April. Declines moderated to (0.7)% in May but the sector s performance was well below that of the apparel category as a whole. Growth in the store-based specialists sector has tended to lag total apparel sales growth because Internet pure plays are stealing an ever-greater share of category spending. And the gap between apparel sales and specialists sales has widened, worsening the pain for the sector. Based on the ONS s monthly data, we have calculated the average spread between growth in total clothing and footwear sales and sales made through clothing and footwear specialists: In 2014, the spread was 55 basis points. In 2015, the spread grew to 153 basis points. In the first five months of 2016, the average spread surged to 374 basis points. Figure 3. UK Clothing and Footwear Sales and Clothing and Footwear Specialists Sales, by Month: YoY % Change 12.0 Sales of Clothing and Footwear Clothing and Footwear Specialists' Sales 7.0 2.0 (3.0) (8.0) 2014 2015 2016 All data in this report are nonseasonally adjusted. Monthly data for clothing and footwear sales are based on a sample of 31 major retailers out of the ONS sample of 900 major retailers. Source: ONS Retail Sales Index/Fung Global Retail & Technology Large clothing chains, in aggregate, saw the downturn begin in March 2015. The recent softening has been driven by clothing specialists rather than by footwear stores. And it was felt first by the biggest clothing retailers, according to ONS data. Large clothing chains, in aggregate, saw the downturn begin in March 2015. These large retailers represent 90% of the sector, and include household names such as Primark, Next and Marks & Spencer, so they are the ones to watch most keenly. 5

The total clothing specialists sector was buoyed through 2015 by exceptionally strong growth among small retailers, although they account for just 10% of the sector. This subsector saw its sales turn down only in early 2016 and that pulled the total sector into negative territory. Small retailers are those with fewer than 100 employees or with revenues of 60 million or less per year. Figure 4. UK Sales by Clothing and Footwear Specialists, by Month: YoY % Change Large Clothing Specialists Small Clothing Specialists Footwear and Leather Goods Specialists 35.0 25.0 15.0 5.0 (5.0) (15.0) (25.0) (35.0) Downturn Begins at Large Clothing Specialists 2014 2015 2016 Source: ONS Retail Sales Index/Fung Global Retail & Technology The sentiment of major clothing specialists has turned more negative, and this includes those that were previously solid outperformers. The unseasonably warm autumn in 2015 concealed the underlying slowdown in apparel sales. What appeared to be a temporary, weatherdriven softness now looks to have been the start of a more sustained slowdown. Top Store-Based Retailers See Softening Demand The sentiment of major clothing specialists has turned more negative in recent months, and this includes those that were previously solid outperformers, such as Next and Primark. Next, for instance, recently cautioned that there may be a cyclical move away from spending on clothing back into areas that suffered the most during the credit crunch. Those areas include travel, recreation and dining out. The figures and comments coming from department stores notably John Lewis and pure plays have tended to be much more positive. For instance, in its three most recent weekly sales updates, John Lewis noted that: Fashion sales were up 10.1% in the week ended June 4. 6

Fashion sales were down 0.7% in the week ended May 28, a rare decline for John Lewis. Fashion sales were up 4.7% in the week ended May 21. Figure 5. UK Major Retailers: Recent Sales Growth and Commentary Retailer Total Sales Growth Commentary Next (0.9)% We believe it is unlikely (but possible) that sales will deteriorate further, and we have seen a significant improvement over the last few days as temperatures have risen. However, the poor performance of the last six weeks may be indicative of weaker underlying demand for clothing and a potentially wider slowdown in consumer spending. Primark/ABF 5% The clothing retail market over the half year has been challenging, especially in the UK. Marks & Spencer General Merchandise Debenhams (UK) John Lewis Fashion only ASOS UK only boohoo.com UK only Source: Company reports (1.9)% In Clothing and Home, we faced a challenging backdrop characterized by price deflation and a flat market. 1.0% We have rebalanced our sales toward nonclothing categories, which has resulted in a strong performance. We are on track to deliver full-year results in line with market expectations. Period Three months ended May 2 24 weeks ended February 27 13 weeks ended March 26 26 weeks ended February 27 6.2% Menswear was up 8.8% and Womenswear was up 6.5%. Fiscal year ended January 30 25.1% Our UK sales remain strong. We remain confident of delivering in line with market expectations for the financial year. We expect to deliver sales growth of [approximately] 20%. 42% We are encouraged by our performance in the first quarter, with revenue growth slightly ahead of our expectations. We now expect sales growth for the financial year of between 25% and 30%. Six months ended February 29 Three months ended May 31 The two major pure plays ASOS and boohoo.com have reported no recent slowdown of any significance. boohoo.com experienced a slowing over Christmas 2014 and into early 2015, but growth has picked up strongly since then. boohoo.com beat analysts revenue expectations in its most recent quarter (ended May 31) and raised its sales forecast for the year. We think that these kinds of gains by pure plays are the key reason the gap between the store-based specialists sector and total apparel sales is widening. 7

Figure 6. ASOS and boohoo.com: UK Sales Growth (%) ASOS boohoo.com 60 50 40 30 20 10 0 2014 2015 2016 Data are for nearest periods to calendar quarters. Neither company reports consistently by standard quarters: reporting periods range from two months to four months. Source: Company reports The retail sector captured just 18.6% of the total increase in consumer spending in 2015. Retail Versus Nonretail Spending We think the real story behind the slowdown is not one of consumer caution, but of the shift in consumer spending from retail to services. The US has seen this trend play out for some time, with shoppers spending on dining out, in particular, while taking a more cautious attitude toward retail, including apparel. The trend is now becoming entrenched in the UK, too. The retail sector captured just 18.6% of the total increase in consumer spending in 2015 a lower share than in any recent year. Back in 2011, for instance, retail was capturing more than a quarter of the total annual growth in spending. So, consumers are growing their retail spending but at an unusually low rate. Figure 7. UK Total Consumer Spending vs. Total Retail Sales: Absolute Annual Growth (GBP Mil.) Annual Growth in Consumer Spending Annual Growth in Retail Sales Difference Retail s Share of Spending Growth (%) 2011 36,047 10,255 25,792 28.4 2012 38,550 8,080 30,470 21.0 2013 43,728 10,255 33,473 23.5 2014 45,886 12,120 33,766 26.4 2015 33,395 6,215 27,180 18.6 Source: ONS Consumer Trends/ONS Retail Sales Index/Fung Global Retail & Technology 8

The recreational and sporting services sector, which includes tickets to sports events, visits to theme parks and gym memberships, posted especially strong growth in 2015. Consumers Prioritize Leisure Spending over Goods The message from spending data for 2015 is clear: consumers are growing their spending on leisure services much more quickly than they are their spending on retail. The recreational and sporting services sector, which includes tickets to sports events, visits to theme parks and gym memberships, was the standout services sector in 2015. Figure 8. UK Consumer Spending, by Selected Category: YoY % Change (2015) 18 16 15.9 14 12 10 9.8 8 6.7 6 4 2 3.0 1.9 2.9 0 Total Spending Retail Recreasonal and Sporsng Services* Hotels Cultural Services** Dining Out *Such as sports events, sports facilities, theme parks and gyms. **Such as cinemas, theaters, concerts, galleries and zoos. Source: ONS Consumer Trends/ONS Retail Sales Index/Fung Global Retail & Technology We see social media such as Instagram fueling the consumer trend of spending on services rather than on goods. It is what we call the Instagram effect. So, consumers are still spending. The squeeze in retail looks to be much less about consumer caution with regard to spending or worries about the Brexit referendum, and much more about consumers wanting to spend on experiences rather than on products. Why Consumers Are Spending on Leisure Services We see two major elements driving consumers to spend on leisure services rather than on goods. First, we think the growth of social media and particularly the shift to photo and video content on sites such as Instagram and Facebook is likely playing a role. Younger consumers tend to enthusiastically document their lives on social media, which arguably puts pressure on them to be seen traveling, attending concerts and sports events, dining out, and enjoying other leisure activities. The result is what we call the Instagram effect on consumer spending. These consumers want their peers to know that they are leading interesting, fun, experiencerich lives. Even Facebook s Mark Zuckerberg has acknowledged the pressures social media can place on consumers. Speaking at the Mobile World Congress 9

2016 event, Zuckerberg admitted that social media can pressure users to present super-curated personalities online. Second, mobile connectivity is making it easier to find and book leisure services, including weekend getaways, salon treatments and last-minute dinner reservations. Apps such as YPlan allow consumers to discover leisure events and activities in their city, and online and app-based booking intermediaries such as Just Eat and Deliveroo in food service are making it easier to spend on services. The effect of these apps is notable, especially in service sectors such as restaurants and beauty, where fragmentation can present barriers to finding and booking services. We show our visualization of this front end consolidation below. Figure 9. The Front End Consolidation of Service Sectors by Apps and Online Services Small Chains Independents Local Players Mobile Apps Online Aggregators Consolida`on Source: Fung Global Retail & Technology Do Apparel Sales Track Economic Indicators? Lastly, we take a brief look at the extent to which growth in the apparel market tracks three key measures: economic growth (GDP), consumer confidence and the PMI for services. Which, if any of these, can suggest the prospects for the apparel market? APPAREL SALES VERSUS GDP Figures from 2012 suggest an approximate correlation between apparel sales and softening GDP growth, which is what we are currently seeing. In its March 2016 forecast, the UK Office for Budget Responsibility outlined its expectations for steady GDP growth across 2016, which should prevent a deepening of the apparel malaise. 10

Figure 10. UK Consumer Spending on Clothing, Accessories and Footwear (Left Axis) vs. GDP (Right Axis), by Quarter: YoY % Change Clothing and Footwear Spend YoY % GDP YoY % 13 3 11 2 9 1 7 0 5 (1) (2) 3 (3) 1 (4) (1) (5) (3) (6) 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: ONS Consumer Trends/Eurostat/Fung Global Retail & Technology APPAREL SALES VERSUS CONSUMER CONFIDENCE The relationship between apparel spending growth and consumer confidence levels looks weak. Although initially it may look like consumer confidence is a leading indicator, the extent of the time lag suggests that the relationship is not direct: confidence began to fall in the second quarter of 2010, but growth in apparel spending did not start to slow until the second quarter of 2012. Figure 11. UK YoY % Change in Consumer Spending on Clothing, Accessories and Footwear (Left Axis) vs. Consumer Confidence (Right Axis), by Quarter Clothing and Footwear Spend YoY % Consumer Confidence 13 10 11 5 9 0 (5) 7 (10) 5 (15) 3 (20) 1 (25) (1) (30) (3) (35) 2008 2009 2010 2011 2012 2013 2014 2015 2016 Consumer confidence level is as of quarter-end. Source: ONS Consumer Trends/Eurostat/Fung Global Retail & Technology 11

APPAREL SALES VERSUS PMI We see something similar when we look at apparel sales growth versus the PMI for the UK services industry: the PMI declined fully two years before the time of the last softening in the apparel market. However, recently, there has been a more immediate link between these two metrics and the continued downturn of the services PMI into 2016 has dovetailed with the recent decline in the clothing and footwear market, adding further weight to our expectations of weak apparel demand in the near term. Figure 12. UK YoY % Change in Consumer Spending on Clothing, Accessories and Footwear (Left Axis) vs. Services PMI (Right Axis), by Quarter Clothing and Footwear Spend YoY % Services PMI 13 11 9 7 5 3 1 (1) 65 60 55 50 45 (3) 40 2008 2009 2010 2011 2012 2013 2014 2015 2016 Services PMI is as of quarter-end. Source: ONS Consumer Trends/Markit/Investing.com/Fung Global Retail & Technology What We Expect Despite the bounce back in May, the short-term outlook for the UK clothing and footwear market is not bright: key indicators such as consumer confidence and the services PMI have been trending downward, although these sometimes do not relate directly to category spending. Recent negative growth in the specialists sector has been unusually severe: April 2016 was the second-worst month for the sector since the end of the recession in 2009. The increasing underperformance of the specialists sector versus overall category spending is notable, and implies that Internet pure plays are accelerating their market-share gains. The unusually negative performance leads us to believe that falling apparel sales will be a relatively short-term trend: even in the 2008 2009 recession, consumers did not cut their spending month after month consistently. We think that the recent period of falling sales will be followed by tepid positive growth. Shoppers will still spend on apparel, but they will be more 12

enthusiastic about spending on leisure services. Moreover, not all retailers will suffer equally. The biggest pure plays, such as ASOS and boohoo.com, are continuing to grow apace, but that is worsening the pain for clothing specialist retailers. 13

Deborah Weinswig, CPA Managing Director Fung Global Retail & Technology New York: 917.655.6790 Hong Kong: 852.6119.1779 China: 86.186.1420.3016 deborahweinswig@fung1937.com John Mercer Senior Analyst HONG KONG: 10th Floor, LiFung Tower 888 Cheung Sha Wan Road, Kowloon Hong Kong Tel: 852 2300 2470 LONDON: 242-246 Marylebone Road London, NW1 6JQ United Kingdom Tel: 44 (0)20 7616 8988 NEW YORK: 1359 Broadway, 9 th Floor New York, NY 10018 Tel: 646 839 7017 FBICGROUP.COM 14