Underweight Retail In addition to Brexit concerns, we also see a number of fundamental reasons to reiterate out underperform on Retail. ¢ Structural margin pressures: Aside from Brexit, retailers face declining returns as online disruptors and discounters drive up competition. EBITDA margins have fallen from 8% in 2010 to close to 7% in 2016 and RoE has declined by nearly 3% since 2004. We think this structural trend has further to run. ¢ Valuations are also unattractive. Retail remains on a significant premium to the market on absolute terms (17.3x 2017 PE vs 14.2x) and is expensive versus its own history at 20% above its 10y relative average on PE and 92%ile on PBV, while it has the second lowest dividend in the market (2.9%). Even if you strip H&M and Inditex the sector is towards the higher range of its post-GFC range. ¢ UK supermarkets have had their relief rally. Despite challenges facing UK food retailers, Tesco has rallied 25% and Morrison’s 15% since Brexit as retail spending has held up and the short base grew massively immediately following the UK-EU vote. Yet as Xavier Le Mene notes, this has largely been because they have gained market share from Asda and investors have bought into their new management plans. However, Xavier see limited upside potential for either next year and there is a risk that Asda starts to recoup lost ground under its new management too. Chart 66: Stiff competition means retail margins are structural declining Chart 67: Market share gains have largely been at Asda’s expense 8.3% Tesco Aldi 7.8% Lidl Waitrose 730% Morrisons “ Sainsbury's ——Retail EBITDA margin Asda 6.8% 100 50 0 50 100 PH LP LD PP WO VW MY WO OO Oo oS a $ & & & & & & & a & & m Market share of grocers, yoy Source: BofA Merrill Lynch Global Research, Bloomberg, Datastream, IBES Source: Kantar Worldpanel Chart 68:Retailisexpensiveonarangeofmetrics Chart 69: Not cheap even if you strip out the two biggest ex-UK names 1.70 —— Stoxx Retail PE ———= Stoxx Retail ex-Indite