How to spot a retailer in trouble

The news from Focus, the rescue of All Saints and the ongoing battle for survival at HMV highlight the dangers in retail today.

Such is the unprecedented potentially lengthy squeeze on personal incomes allied to cost pressures, the maturity of the UK’s retail structure and the challenges posed by the online revolution that, to date, the casualties are perhaps only the tip of the iceberg. Wouldn’t it be good if we could identify the likely casualties well ahead of events?

There is a multiplicity of possible danger signs but most symptoms only become evident when it is too late. Prime examples might be directors selling shares, credit insurance issues, management departures and selling the crown jewels – those assets that are saleable such as HMV’s store on Oxford Street.

Possible earlier signs could be strategy shifts, changing auditors, moving to a more expensive head office and delays in producing figures – bad numbers always take longer to prepare.

I’d highlight three acute areas for concern. First, a high level of exposure to the online threat where the frontrunners – music and book retailers – have already gone or are fighting a desperate rearguard action.

Game and DVD stores are suffering and consumer electronics – Best Buy, Comet, Currys, Maplin and phone shops – cannot be far behind.

On a medium-term view I worry about the adjustments that clothing and food retailers will have to make to accommodate increasing online penetration and home delivery.

The second acute danger is a high level of fixed costs or debt. Happily, a retailer’s major cost is variable: the nature of the retail labour force (young, part time and female) brings with it high turnover – not good for service levels but it provides flexibility when sales are slow.

The second biggest cost is a different matter: rental costs are not only fixed but are long-term liabilities and only go in one direction – up.

Hence the resort to a CVA and the number of retailers that choose to enter administration in order to jettison the most onerous leases and loss-making stores, only to subsequently buy back the better stores from the receiver.

I have always regarded a high and rising rent to sales ratio as a big warning signal, yet management rarely talks about this ratio.

With debt, the issue is not just what might happen to interest rates but that periodically debts have to be refinanced. The amount of debt that a bank today finds comfortable is significantly less than pre-credit crunch.

My third factor is more ephemeral but often the most scary – a management in denial, refusing to accept bad news and always confident everything will be fine next week.

It is a culture of excuses – the weather, late Easter, etc – and can be characterised by hyper-sensitivity to criticism with litigation threats and a refusal to speak to the media. There have been companies, for example, that have banned a particular analyst from their briefings – no prizes for guessing which analyst.

But every cloud has a silver lining and the problems at a retailer like Focus become others’ opportunities. No doubt Chris Dawson at The Range, for instance, will be taking advantage.