Why the profit warning from ASOS has added to the retail gloom

Retailers are hoping for a busy New Year period following a very tough year of trading. Much of the current market analysis and speculation has placed the blame for a host of high-street insolvencies on a rise in online shopping and skyrocketing rents for stores.

However, the recent news that online fashion retailer ASOS has issued a profit warning has set more alarm bells ringing. If online sales can’t prop up the struggling stores then the retail sector really is in crisis.

2018 saw big retail brands continue to fall into insolvency due to a decrease in footfall and increasing rents. It was a year where many of the most recognised household names – including House of Fraser, Poundworld and Toys ‘R’ Us – succumbed to a deadly cocktail of tough trading conditions, decreased footfall and the rise of online shopping, leaving them unable to pay their debts as they fell due.

Many retailers are over-leveraged and cash flows are tight due to consumer habits changing on the high street. The popularity of online retail continues to grow, fuelling the ‘bricks versus clicks’ debate and retailers with physical stores are having to fight hard to capture footfall.

This dearth in high street sales has been blamed on online retailers like Amazon and ASOS, as well as continuing uncertainty over Brexit and the underlying economy. However, ASOS’ profit warning further increases concerns over the retail sector and the economy as a whole. The inevitable questions must be asked – is political and economic uncertainty making consumers just too scared to spend? Or does Amazon now have a monopoly over the entire retail sector?

One phrase which has dominated the dialogue around insolvencies and collapses in the retail sector is the Company Voluntary Arrangement (or CVA) which many retailers turned to as a last-ditch attempt to keep their businesses afloat.

CVAs are formal processes by which a company and its creditors enter into an agreement whereby a portion of the company’s debts are paid over a set period of time.  As the success of a CVA depends heavily on agreement between creditors and the company itself, they have often been favoured by businesses which may still be viable, but have fallen on hard times.

In 2018, many established names on the high street such as Carpetright and New Look reached agreements with their landlords which allowed them to shutter stores or reduce their rent.  CVAs are quite literally taking over the high street.

However, the ‘year of the CVA’ has drawn a significant number of critics, particularly in the retail space. The nature of CVAs means that store portfolios are often streamlined and in many cases this can involve imposing rent reductions or even allowing tenants to break out of leases at an early stage.

This has had an obvious knock-on effect, predominantly for retail landlords who have experienced their rental income streams dropping. Indeed, the sheer number of CVAs which were put in place during 2018 has sparked a huge backlash, with many critics calling for the process to be reformed completely.

However, even for landlords and other creditors the ever-increasing use of the much criticised CVA is the lesser of two evils. Demand for a change in insolvency legislation grows apace but one thing looks certain – the short-term future for the retail sector is quite grim and CVAs are now part of the landscape.

By Michael Mulligan, insolvency partner at law firm, Shakespeare Martineau