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Retailers Expose Dramatic Weakness in U.K. Economy

Stocks in this article: WMT

NEW YORK ( TheStreet) -- So what if the U.K. economy grew 0.8% in the three months from April to June? Those statistics don't reflect the true state of the souring U.K. economy. You want proof? Look no further than the retail scene in Great Britain.

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According to consultancy firm Kantar, grocery store sales in the U.K. reached a 10-year low in the 12 weeks ended Aug. 17, declining 0.8%. Grocery price inflation declined 0.2%, representing the 11th consecutive period of decreases, due to intense pricing competition. It was the weakest reading since October 2006.  Sales for U.K.-based grocery store retailers  Tesco  (TSCDY) and Wm. Morrison fell 0.4% and 1.9%, respectively, while Asda, which is owned by  Walmart (WMT) , notched a 1.2% increase, slightly ahead of rival  Sainsbury's 0.3% improvement.
 


The sales sluggishness has not been confined to the grocery store sector.  U.K. retail sales excluding fuel sales have declined in four of the past seven months, per data from Bloomberg.  July retail sales rose 0.5% according to the Office for National Statistics, following a 0.1% decrease in June, and came despite an 0.8% jolt from clothing and footwear sales. Holding down July sales was none other than food -- sales by volume fell 1.3% from a year earlier, the first annual decline on record, reflecting price wars in grocery store aisles.  

Tesco's Aug. 29 second-quarter earnings warning punctuated the challenging sales environment for U.K. grocery retailers.

"The combination of challenging trading conditions and ongoing investment in our customer offer has continued to impact the expected financial performance of the Group," said a company spokesperson in what amounted to the company's third profit warning in eight months. In the first quarter, Tesco's then CEO Philip Clarke noted, "The first quarter has also seen a continuation of the challenging consumer trends in the U.K., reflecting still subdued levels of spending in addition to the more structural changes taking place across the retail industry."

Tesco's first-quarter sales in the U.K. declined 2% in constant currency compared to a 1.5% increase for its Asia segment and a 0.6% fall in Europe.

Shares of Tesco have shed about one-third in 2014.

Wm. Morrison has only increased its sales once in the past eight months, a 2.4% gain for the four-weeks ended Aug. 17, as highlighted in data from Kantar. Like many of its competitors, Wm. Morrison is lowering prices to lure in U.K. consumers heavily favoring the aisles of discount chains Aldi and Lidl. The company slashed prices on 1,200 products since the end of April. The cuts are part of a £1 billion investment in more competitive prices and product improvements over the next three years by the grocery store retailer.

For its part, Tesco announced a £200 million price reduction campaign back in February.

Sources of the cutthroat pricing and sluggish sales in the U.K. retail market are two-pronged -- a stronger pound is making it more expensive for tourists to spend in the country and weakening earnings growth for British citizens. The lackluster sales in the U.K. are even starting to inflict financial harm on western retailers.  

"We think the weakness in the U.K., and to some degree on the continent, might be resulting from the strength of the pound and euro, which perhaps could also be enticing Europeans to shop in the U.S. and elsewhere," said Tiffany & Co.  (TIF)  during its second-quarter earnings call on Aug. 27. Tiffany doesn't disclose its U.K. sales, however a company spokesperson said via email that the fine-jeweler operates 10 U.K. locations, and that the country accounts for a "bit less the half of European sales." Tiffany said during its first-quarter earnings call in May that "trends were similar in the U.K. and in continental Europe", demonstrating how economic conditions have deteriorated in just about three months.
 
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As for wages, the U.K. Statistics Office reported that second-quarter average earnings fell 0.2%, the first drop since 2009. Average earnings growth excluding bonuses has moderated for three straight months, clocking in at 0.6% increase in June. Year-to-date sales trends at Walmart's Asda division, which is the second-largest supermarket in the U.K. and the second-biggest market for the company behind Mexico at 583 units, sheds light on the stalled household earnings growth.

"The U.K. had a solid quarter, growing both net sales and comp sales despite a challenging market backdrop," said Walmart International President and CEO David Cheesewright on the second-quarter earnings call last month. Same-store sales increased 2% excluding fuel sales, despite the "aggressive price investments from competitors," Cheesewright said. However, the sales increase came at the expense of profits -- operating income "declined slightly due to a lower margin mix" in the quarter. Asda's second-quarter performance followed a start to the year marked by a same-store sales decline in the first quarter, with Cheesewright mentioning a "tough market backdrop."

Even teen apparel retailer Abercrombie & Fitch (ANF) has joined in the parade of warnings on the state of the U.K. economy, while warehouse club operator Costco (COST)  has not blown the doors off with its sales in the country this year at its 25 locations. "The U.K. remains tough," said Abercrombie CEO Mike Jeffries a week ago on the company's second-quarter earnings call. An Abercrombie & Fitch spokesperson replied via email when asked about U.K. sales, "we can't provide that level of detail for the change in net sales, but per our call last week, year-of-year comps were down in the U.K. for the second quarter." Abercrombie & Fitch's U.K. business is led by 31 Hollister stores, followed by one namesake location, and as of Aug. 30, a single Abercrombie kids store.

Costco's "performance of the U.K. has been in line with the rest of the business globally," according to a company spokesperson in an emailed statement.

The U.K. economy doesn't appear to be out of the woods thus far in the third quarter, some nine months before the next election for prime minister.According to research outfit Markit Economics, U.K. manufacturing activity expanded the least in a year last month. The latest data backs up an early August warning from Bank of England governor Mark Carney, who said the economy "faces challenges" and that the governing body is in "no rush" to hike interest rates.
 
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At the time of publication, the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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