This article was originally published in Retail Week on the 15th December 2021.
For consumers, on the one hand, savings have rarely been higher as a proportion of their income.
On the flipside, alongside an undoubted willingness to divert spending towards travel and leisure, consumers face much higher costs of living with significant tax increases, higher energy bills and wider inflationary pressures in travel and council tax particularly.
For business models, for the first time in many decades, opening shops looks attractive because of the continued high inflation associated with digital channel marketing.
It could look more attractive if the government seeks to understand the industry. It might finally examine the future of business rates and conclude that bricks-and-mortar outlets are powerful marketing channels for brands and must therefore become a variable cost in line with its variable cost-driven digital competitors.
For brands, budgeting is fraught with volatility because of Covid-related comparatives and stock management has rarely been so problematic.
Brands also face structural inflation that has seeped into wages at all levels alongside a sharp increase in staff turnover.
The supply chain remains as challenging as we have ever seen it. Alongside exceptional freight costs due to Covid-related supply and demand imbalances, the elongated Chinese New Year, ongoing lockdowns in Asia –most notably in Vietnam – the threat of a new, more transmissible virus variant and elongated working capital cycles offer up the very real risk of some companies requiring further cash to survive.
Combining all these suggests a difficult 2022 for our industry. But it could present an opportunity to invest at historically sensible valuations in strong digital-first brands as the reality of trading bites.
Even more perplexing in recent days are the self-publicised ‘stock-holding winners’ embarking on significant Black Friday activity, sacrificing both brand equity and margin at exactly the point when many competitors don’t have the inventory to compete.
“2022 could present an opportunity to invest at historically sensible valuations in strong digital-first brands as the reality of trading bites”
As I write, price expectations will need to be rebased to make this market liquid again. Even the low-growth UK public market participants remain more than 20% above 15-year valuation averages, despite many being seen as ‘legacy operators’.
Due to global fiscal policy, the mismatch between valuations and future anticipated performance has never looked so wide, especially in the US.
The recent Allbirds IPO, where economics are unproven and the valuation is more than 10 times sales, showcases the challenge investors have at this juncture.
Unless timing was perfect, very few participants and certainly public market investors, are likely to make a financial return.
One venture capital firm has completed more than 300 deals in a single calendar year, many consumer-facing.
The valuations of loss-making early-stage brands, over-reliant on Facebook as a customer acquisition tool, remain at elevated levels when benchmarked against any period in history.
Taking all of the above into account, I suspect that 2022 will serve investors a stark reminder that growth without regard to return on investment doesn’t create value.
Looking at the UK, it is notable that ‘value’ stocks such as M&S have outperformed ‘growth’ stocks such as Asos and Boohoo this calendar year.
As Covid disruption annualises, everyone faces the same pressures next year. Such pressure may deliver quite seismic changes in business models as boards are forced to look at every aspect of their business again.
“What we love about digital-first, direct-to-consumer brands is that they have the potential for significant structural growth, strong business models, excellent return on capital employed and strong free cash flow generation”
So, what to do as an investor? Consumer spending makes up over half of the economy and investors, accordingly, must play.
What we love about digital-first, direct-to-consumer brands is that they have the potential for significant structural growth, strong business models, excellent return on capital employed and strong free cash flow generation.
They are also able to partner dynamically with technology providers without bringing the associated R&D burden on the balance sheet.
Cash flow and innovation are often overlooked by commentators. We believe that, as growth rates converge over time, this point will become a real focus for investors because it will enable these brands’ strategic flexibility to take market share on a systematic basis.
At True, we will continue to look for large, fragmented, long-tail markets with powerful demand tailwinds where digital-first brand owners and entrepreneurs have a real point of profitable difference through the business model, brand and product.
Whatever you pick, pick carefully. Happy Christmas.
