Citi highlights preference for Halfords, Dixons Carphone as it reviews retailers

Citi said it was not yet ready to turn more positive on the UK cyclical names as it recommended investing in online retailers rather than their bricks and mortar counterparts.

"E-commerce has significantly changed the retail landscape and we do not think this online revolution has finished. In fact, we argue that the tipping point is only just being reached at a number of our retailers and the market dynamics will get even tougher for them in the next few years."

The bank expressed a preference for Dixons Carphone and Halfords, but said its least preferred stocks were B&Q owner Kingfisher and Next.

It upgraded Halfords to 'buy' from 'neutral' and lifted the price target to 375p from 350p, saying it offers exposure to underlying growth categories of cycling and motoring as well as robust cash generation.

"The investment in a service based offering provides a greater degree of protection against online competition, which helps sustainability of earnings. In the short term we expect share gains to come from competitor exits in both the cycling and motoring parts categories, as well as a potential profit uplift from recovering the recent FX headwind on cost of goods sold."

Citi cut Marks & Spencer to 'neutral' from 'buy' and dropped the price target to 260p from 400p saying the impact of store closures on the bottom line has been underestimated by the market.

"Whilst we appreciate the significant structural overhaul of the cost base, it may take time to see an improvement in the clothing and food LFL sales performance. The strategy is heading in the right direction but we need to see more evidence of delivery."

The bank downgraded Next to 'sell' from 'neutral' and reduced the price target to 4,350p from 4,650p saying the company is likely to suffer from further online deleverage given the weak retail LFL. Citi expects the sales transfer into Directory to slow.

"Net space growth is likely to change to a net space reduction in the next three years putting further pressure on the central cost base. Directory growth is being fuelled by lower margin third party and international sales growth. With base rate increases coming we think there may be an increased risk on bad debts from the £1bn credit book," it said.

B&M Retail was cut to 'neutral' from 'buy' and the price target kept at 425p. This was attributed partly to valuation given its relative strength compared to the sector and partly as Citi thinks the drivers of its LFL performance are set to fade.

"Although the UK consumer has not yet turned more positive the indicators suggest that real wage growth is returning, food inflation is fading and the grocers are improving their offer. We need to see more European growth for further upside."

The bank cut online fashion retailer ASOS to 'neutral' from 'buy' and lifted the price target to 7,750p from 7,600p. While it sees "substantial" long-term opportunity for growth, Citi is worried that the market is overly optimistic on current, and therefore future, profitability and that there is a real risk that ASOS is under-investing in future growth.

"Recent US dollar weakness and the CFO departure are further headwinds," it added.

Pets at Home was cut to 'neutral' from 'buy', with the target price trimmed to 180p from 210p. The bank said it was still confident that services can be a large driver of profit and cash generation for the company over the long term. However, merchandise profitability is likely to remain under pressure due to online competition and this will limit profit growth and cash return over its forecast period. "We do not see scope for re-rating over the medium term," it said.

Dixons Carphone was kept at 'buy' with a 230p price target. Citi pointed out that it controls more than a third of the UK electricals market and despite the incessant rise of Amazon and Apple, it has gained share over the last decade as weaker incumbents have failed.

"It has strong cash generation that warrants at least a sector average multiple. The mobile business is currently valued at zero by the market, but continues to hold inherent value, while the European assets are underappreciated by investors in our opinion."

Citi kept Kingfisher at 'sell' and cut the price target to 270p from 285p. It said the short-term risks to earnings from a weaker UK consumer and the uncertainty over delivering the £350m of sourcing gains through to the bottom line leave it cautious, given consensus had priced much of this in.

"In the short term we are not sure that Bunnings will exit the UK market as quickly or as quietly as some expect."