HSBC downgrades Dunelm, Halfords over 'toxic' squeeze on consumer spend

With the retail sector's risk profile increasing as the UK discretionary consumer outlook deteriorates, HSBC downgraded and cut the target prices Dunelm and Halfords, but upgraded Kingfisher to 'buy' due to its transformation plans.

HSBC has taken a more cautious view of retail due to a backdrop of increasing macroeconomic risk, as the strong data post the Brexit referendum has begun to be riven by cracks.

Not only have inflationary headwinds become increasingly obvious, demonstrated by Tuesday's CPI of 2.7%, but consumers’ budgets are being squeezed as real wage growth has turned negative, creating increasing threats to demand for retailers.

"In addition, inflation in inelastic areas such as food is accelerating, which will further squeeze discretionary demand," the bank's analysts said.

"The situation is made worse for non-food retailers as cost inflation is feeding through as hedging programmes roll off."

This suggested the second half of the year will see non-food retailers face a period of falling demand and rising costs - "a toxic combination".

HSBC increased the risk profile for its UK retail coverage by applying a 10 point premium or discount to the observed beta - the relative volatility of a stock in comparison to the wider market - of UK retailers where they are seen to be exposed to risk or favourable areas or trends.

The UK risk added to the beta of Dunelm and Halfords and saw HSBC cut their target prices from 800p to 640p, and from 415p to 380p, respectively.

N Brown's UK risk was balanced out by positive beta for its growing online presence, meaning its target price was kept at 280p.

For Kingfisher, its transformation plan is seen as "radical, ambitious and has a lower risk than headline performance targets suggest", with the target price lifted to 440p from 380p.

HSBC believes management is ahead of plan on several parts of the transformation that are key to its success, including the unified product offer and low risk implementation of new IT systems into the UK and France.

Against a backdrop of relatively supportive DIY markets, analysts forecast a three-year EPS compound annual growth rate of of 11%.