RBC sees muted outlook for European retail amid weak spending trends

RBC Capital Markets projects a muted outlook for European retail, citing anticipated household spending cutbacks as the primary impediment to top-line growth, despite favorable gross margin conditions driven by a weakening U.S. dollar. The report highlights significant divergence across the sector, with RBC cutting EPS forecasts for companies like H&M (1-7% for 2025-26) and WH Smith (22% for 2026 PBT), while raising forecasts for JD Sports (3-5% for 2026-27). This divergence is reflected in varied stock recommendations and valuation concerns, with Inditex deemed "full" at 22.5x 2025 earnings, underscoring that gaining sales momentum remains the main challenge for the industry.

Analysis

RBC Capital Markets presents a cautious and bifurcated outlook for the European retail sector, flagging weak consumer demand as the primary headwind that is likely to offset favorable gross margin conditions. The central challenge for retailers is generating top-line growth amidst consumer cutbacks driven by household cash flow pressures, higher taxes, and the rising cost of living, a situation exacerbated by tougher year-over-year comparisons from strong Autumn 2024 trading. Conversely, profitability is being supported by significant tailwinds, including a 5% year-on-year weakening of the U.S. dollar against the euro and pound in Q2, combined with excess sourcing capacity. This divergence is creating clear winners and losers. RBC has raised its 2026-27 forecasts for JD Sports by 3-5% and rates it "outperform," while cutting its 2026 profit estimate for WH Smith by 22%. Major players like H&M saw EPS forecasts for 2025-26 trimmed by 1-7%, while Inditex's valuation is deemed "full" at 22.5x 2025 earnings given its modest projected EPS growth of 2% for that year. This selective performance is further reflected in RBC's ratings, with Next, Marks & Spencer, and Zalando also earning "outperform" ratings, contrasting with "underperform" ratings for Inditex and Boohoo.

Key Decisions for Investors

• Investors should adopt a highly selective, stock-picking approach rather than a broad sector bet, focusing on companies demonstrating resilient top-line growth like JD Sports, which received an earnings forecast upgrade.
• Consider the valuation risk in market leaders such as Inditex, which RBC describes as having a 'full' valuation at 22.5x 2025 earnings against a backdrop of low single-digit projected earnings growth.
• Monitor upcoming sales figures closely, as top-line momentum is the critical catalyst for a potential rerating, especially for companies like H&M that are trading at lower multiples but have yet to demonstrate broad-based sales improvement.
• Recognize that while favorable currency exchange rates are providing a margin buffer, this should not be confused with fundamental operational strength; the primary focus remains on a company's ability to navigate a challenging consumer sales environment.