Amazon, Arcadia, Sainsbury, Segro: All big names in the UK logistics property sector. But 2020 could mean big challenges for each of them, as David Thame reports.
The future has rarely been less certain for logistics, and for pretty much everything else in the UK economy. A general election that tangles or untangles the political threads will have unpredictable consequences for trade and economic policy. Brexit clouds everything.
Yet for some of the biggest names in the world of logistics property, there are additional private uncertainties. Strategies are developing or failing, business plans working like clockwork or collapsing in tatters, whilst the head winds of competition or consumer resistance are opening or closing doors.
Here is SHD’s rundown of four of the big names to watch in 2020.
Amazon goes for growth
The customer offer from Amazon has ramped up dramatically. Long gone are the days when 24-hour fulfilment was ecommerce industry standard. Now Amazon will deliver to many UK addresses within the day, and for some Prime customers within hours or minutes. But such innovation does not come without cost, and it is one Amazon are starting to feel.
In this case, as so often, trends which begin in the U.S. online sector provide an early warning about the potential for disruption in the UK.
Last month Amazon revealed that it had suffered 26% year-over-year decline in profits in the third quarter, news that ended nearly two years of continual profits growth. Whilst turnover was up 24% to a staggering $70 billion, an aggressive last-mile expansion programme had eaten into profit. The ecommerce giant spent more than $800 million in the spring quarter alone, and an undisclosed but even larger sum in the autumn quarter. The target was $800 million. The final quarter of 2019 was expected to take costs dramatically higher.
The difficulty for Amazon is that its ambition and reach make them their own worst enemy in a property market with relatively little good quality stock on offer or under development. Massive demand from Amazon pushes up warehouse rents, which pushes up Amazon costs, which leads in turn to the sudden decline in profits. That every other parcels and ecommerce business is also in the market for new floorspace simply exaggerates the trend, especially in the densely-populated areas where Amazon makes its most time-sensitive delivery offers. Add to this competition for labour, which drives up the wage bill, and Amazon’s headache becomes all too apparent. That Amazon’s efforts to create its own shipping subsidiary proved to be costly (no surprise there) adds to the dilemma.
Meanwhile there is pressure from another direction: customers. There are modest signs that we have reached peak-Amazon. Customers are beginning to look elsewhere. Assorted consumer research in the U.S. points in this direction. The data also suggests that Amazon Prime membership growth may be tailing off (or perhaps shrinking). Amazon’s response is to redouble its promises on rapid delivery.
At some point something has to give. Either Amazon sacrifices more profit, or more customers, or trims back its delivery offer. Sometime in 2020 we will find out which.
Arcadia goes to pieces
The ecommerce firestorm continues to burn, and Sir Philip Green’s Arcadia Group is one of those feeling the heat.
Arcadia embraces some of the best known fashion names on the high street. From Top Shop, Dorothy Perkins to Evans and Burton, its customer base embraces almost everyone. But a lack of investment has left the Arcadia brands looking tired compared to online upstarts like Boohoo, and a large legacy of often expensive high-street shops is a drag on earnings. Turnover fell 4.4% in the year to 1 September 2018, the most recent available, whilst profit (before tax and deductions) plunged to under £100 million. A large and ominous pension liability hovered in the background casting a shadow over the capacity of the business to survive without radical change.
Under this pressure seven company voluntary arrangements (CVAs) were agreed by creditors in June 2019. The result was 48 UK store closures and rent cuts at 194 other locations.
The longer-term answer for Sir Philip might be to sell-off the most promising parts of the Arcadia empire, and let the remainder find its own market level (or grave). This would entail untangling some of the complex relationships between brands such as IT, human resources and supply chain. And this is where the logistics sector gets interested, thanks to numerous stories that Arcadia are indeed separating supply chains ahead of a de-merger
Chatter about a logistics divorce may have been inspired by the opening this year of a new Daventry warehouse for the Top Shop/Top Man fascias. A deal agreed with Prologis in 2018 means Arcadia has a new 535,000 sq ft warehouse at DIRFT, close to junction 18 of the M1 motorway. Mezzanine floors bring total floorspace up to around 1.2 million sq ft.
Both Top Shop and Top Man were previously managed from the group’s existing warehouse in Milton Keynes. Part of the operation has already gone live at Daventry, with the rest to follow in spring 2020. Arcadia, meanwhile, hot denies any form of split or de-merger is in process or contemplated.
Of course the big question is, will a de-merger work? Analysts wonder whether anyone will want a business based in stores spread around the UK, many of them in the kind of third- and fourth-tier shopping towns which investors suspect will not survive the ecommerce revolution. And even if somebody did want to buy a portfolio of shop leases, who pays for Arcadia’s large pension legacy?
The outcome for one of the largest players in the retail logistics scene remains very unsettled as 2020 begins, and it is anybody’s guess where it will end.
Sainsbury goes local
This time last year the talk was dominated by the potential for an Asda/Sainsbury merger that, had it succeeded, might have meant serious re-thinking of supply chains and logistics property. With the competition authorities ruling-out the merger, Sainsbury is now back on its own and facing all the old problems the ill-fated Asda move was meant to resolve.
In November 2019 Sainsbury’s revealed nosediving profit figures, down 91% to just £9 million in the six months to the end of September 2019. The supermarket chain blamed this, in part, on the £203 million cost of closing a number of stores (itself part of a wider £500 million cost-cutting plan) but the real problem is pricing and product ranges as the underlying profit figure showed. If you exclude property write-downs, pre-tax profits were down 15%. OK, that’s less than 91%, but still isn’t brilliant.
Sainsbury’s property re-think means 125 stores close, including 60-70 standalone branches of Argos – but that plenty more will open adding to the overall total. Most of the new stores will be smaller Sainsbury Local convenience stores (up by a net total of about 70), with the consequent need for more intensive local distribution and supply chains.
Where that re-think takes a grocery business that has not always been surefooted about its distribution property requirements remains to be seen. Google Teeside and Exeter for conspicuous examples of on-off warehouse schemes that have ended in embarrassment. During the next 12 months we’ll get a chance to see if, this time, Sainsbury has got it right.
Segro goes global?
Prologis, the US-based logistics property empire, has dominated the global logistics scene for a decade. There is scarcely a market in which they are not either top dog, or a close second. UK rivals like IDI Gazeley and Segro cannot match their firepower. But could that change?
Speculation that US private equity house Blackstone may be hunting down opportunities to create a rival to Prologis have been audible, in a low key whispered way, since summer 2019.
Blackstone have been in this sector before. In the middle of this decade they created, then sold, Logicor, offloading it in 2017 in a $13.8 billion deal with China Investment Corp. They subsequently re-acquired 10% of the business in what was interpreted as a goodwill gesture to their new friends in China, but it was not assumed to be the start of a major re-investment in logistics floorspace. Until this year, that is.
Over summer 2019 Blackstone completed the $18.7 billion purchase of a Singapore-based investor's 179 million sq ft U.S. logistics portfolios. This was a fairly big hint that Blackstone have a plan. It was followed by an intensification of their investment in Mileway, a European portfolio dedicated to last mile delivery operations. In media interviews Blackstone made it clear they had an appetite for mergers and acquisitions that could help grow their portfolio.
Rumours have since circulated that Blackstone were eyeing up Segro, the London and South East shed developer with big ambitions in the Golden Triangle big box scene. Speculation was fuelled by a 2014 deal in which Segro sold a 2 million sq ft portfolio to Blackstone for £153 million.
The deal, if it happened, would make sense: Segro are strong in London and the South East, which would fit neatly into the Mileway portfolio. They have extended their skills into big box development and are serious-money makers, something no investor can afford to ignore.
Segro is now worth around £9.3 billion, judged by market capitalisation, and enjoys amazingly low loan-to-value rations of around 27%. In other words, they are as solid as a rock.
Blackstone could certainly afford Segro if they wanted to buy it. Segro’s shareholders might consider it a good deal, if it was priced appropriately. But Segro’s spokespeople have poured cold water on the idea. Wise heads might think “well, they would say that wouldn’t they” and prepare for some big news in 2020.
Are we moving into the age of connected Warehouses?
SHD Logistics' November 2019 property report by property editor David Thame.
Last month British online fashion retailer ASOS reported a 68% slump in profits. It was grim news for one of the trailblazers of online retail, and it puzzled observers who thought ASOS had the teens-and-twentysomething’s fashion scene cornered.
The answer soon emerged: the huge profit slump was due to automation problems in its Berlin hub warehouse in Germany, and similar problems in the United States. Shares surged once again as ASOS disclosed that it is working on a major overhaul of its warehouse and technology capabilities, as it transforms from a UK-centric pattern to a more genuinely global logistics set-up.
This little tale, one of many dozens of similar little tales, shows how central automation has become to retail profits, both online and offline. And that, in turn, reflects on the warehouse property itself, a lesson not lost on the developers, investors and brokers who provide it.
But has the logistics property business fully grasped the requirements of the connected modern warehouse? Or are they offering the same old product, hoping occupiers will be able to adapt them to fast-changing automation needs? Do connected warehouses add up for the property business?
Nestlé and XPO Logistics
The answer is a bit more complicated than a simple yes or no. Take a trip to Leicestershire to see how the industry is reacting. In July last year Nestlé and XPO Logistics agreed to work together to create what they called the ‘digital warehouse of the future.’
The pair are behind a 638,000 sq ft distribution centre at the new SEGRO East Midlands Gateway Logistics Park close to junction 24 of the M1 motorway at Kegworth, Leicestershire.
The Nestle facility will be a testing ground for new XPO Logistics sector technology and, presumably, a big help to consumer distribution in the meantime, and is due for completion next year. The site will feature the latest robotics and automation co-developed with Swisslog Logistics Automation.
James Polson is London-based national head of the Industrial & Logistics Division at property consultant Lambert Smith Hampton and was involved in the property deal that enabled the Nestle/XPO warehouse. His testimony suggests that the property sector is treading a fine line between satisfying logistics sector needs for connected warehouses and imposing expensive and perhaps unnecessary (or simply useless) add-ons.
“We’re in the middle of a transition from shops as retail locations, to sheds as retail locations, and we are still doing a lot of that in the buildings of the past, which are still being built. That creates problems and tensions. So with the Nestle deal the building is not absolutely what the funding institutions expect, but it is cutting edge,” Polson says.
“The big issue is the infrastructure required to support each building’s, whether that is digital connectivity or power, and all we know today is that needs will be very different for each individual operator. There is no one size fits all rule, and so developers and landlords look at this and think ‘how can we come up with a building that suits as many potential occupiers as possible.’
“I think the property industry is waking up to the compromises this involves, but perhaps not at the speed some occupiers would like. But, again, the difficulty for developers is that what suits occupiers is changing all the time. In the 18 months it takes to build a warehouse, a really cutting-edge innovation could go out of date. It’s as quick as that.”
In other words, landlords and developers have powerful incentives to keep warehouse property simple and flexible. They want to be up-to-date but not so painfully modern that innovations age quickly into redundancy.
For a truly connected warehouse to work, many landlords believe they need to focus less on fancy innovations, or the mysteries of 5G wifi, and perhaps a little more on some very basic issues like the availability and capacity of electrical supply.
“Robotics, automation, electric vehicles, these all take vastly more electricity than developers have been used to providing at warehouses,” says Polson.
“Traditionally landlords would have looked at 200 kva power capacity for a warehouse. That has now been stretched to 50-750-kva for a warehouse with a clever stacking operation. Today the minimum is probably 1mba, so roughly five times what the capacity requirement was only a few years ago, and a half to a third up on even recent experience, if the evidence of recent pre-lets is reliable.”
Developers are responding by reserving electrical connections earlier in the process, and being more inventive, adding extra electrical capacity by installing solar panels and other fuel-efficient or energy-creating measures. The difficulty is that even the solar-panelled roof of John Lewis’ 1 million sq ft warehouse cannot make up for an inadequate grid connection, and adequate grid connections are expensive and hard to make.
“For developers, electrical power is an unknown. It is in the hands of regional providers, and you cannot argue with them. They tell you the costs and the timescales and if they decide you need a new substation then the costs can rise dramatically. This is a liner on the budget that is usually in hundreds of thousands but can rise into millions, and in those circumstances, developers are balancing the costs and the risks,” says Polson.
The particular cost they are balancing is the huge up-front cost of installing a large-capacity power supply well ahead of construction, which is the best time to reserve supply if you don’t want to find yourself crowded out of the market. The risk they balance it with is that they will have spent a small fortune only to see a site undeveloped for years, or the building sit empty (which is extremely costly) or, worse, to discover the power wasn’t needed, or is in any case still inadequate to occupier’s needs.
“The trouble for developers is that booking a large power supply isn’t a simple issue like buying a good motorway site. It’s just not so simple,” says Polson.
Expensive waste of time
Then comes issues of digital connectivity, and this is an area with which some in the property business do not wish to become involved. The difficulty is a variation on the problem they face with electricity supply: whatever they do may turn out to be an expensive waste of time.
“Yes, everybody wants fibre optics, but every occupier has different occupier needs on connectivity, everyone likes to choose their own providers, every provider is different, and this is a huge task if you are asking landlords and developers to sort it out,” says Polson.
“Of course, landlords and developers can smooth the way, they can make life easier for occupiers, but not making a fuss about wayleaves both in lease paperwork and on the industrial estates themselves. They can adapt the paperwork, be helpful, not just say ‘no’ or make it complicated. But in the end they are always reluctant to go much further to provide facilities themselves because they are always worried that occupiers will simply rip it out.”
The most useful contribution developers can make, say some insiders, is simply to stay silent and concentrate on basics like providing the larger yards required by the increased traffic flows generated by well-connected digital warehouses.