Investment Column: Bag Halfords as it hits the acquisition trail

At first glance, the writing is on the wall for listed non-food retailers. The confidence of consumers, who are feeling the pinch from rising petrol and grocery prices, as well as tax increases, already seems to be faltering.

A further tightening of their purse strings seems inevitable because the Government will impose swingeing public-sector job cuts in its October spending review, VAT will rise to 20 per cent on 4 January and clothing prices look set to jump by up to 8 per cent next year owing to supply chain cost pressures.

However, whisper it quietly, the reality may not be quite so gloomy for the brave investor considering putting some retail shares in their investment shopping basket. For a start, such shares are starting to look cheap, given that the forecast 2011 price-earnings (p/e) ratio for general merchandise retailers is just over 10, compared with a long-term average of between 12 and 13.

The City has already priced in bad news for the high street and expects downgrades, although the economy will grow faster next year. But you write off the resilient UK consumer at your peril and so far 2010 has turned out to be far better for the high street than most analysts expected.

Furthermore, the dreary August weather has got autumn sales of jumpers and coats off to a strong start. While these factors bode well for the sector ahead of the crucial Christmas trading period, and reinforce our view that the sector is not heading for a sharp downturn similar to that of late 2008, we take a cautious view with our top four picks in the sector.

These include the plus-size home shopping specialist N Brown (whose shares we tipped at the start of this year), the maternity and baby products retailer Mothercare and the homewares and furnishings chain Dunelm – but our top tip is Halfords.

The bicycles-to-car parts retailer, which currently trades on a 2011 p/e ratio of 10.7, has long been touted as a defensive stock, but we think its acquisition strategy could further oil its shares over the coming year. In February, Halfords expanded its servicing and repairs business by acquiring Nationwide Autocentres, which had 224 outlets at the time, for £73.2m. Last month the chief executive, David Wild, said Halfords was considering up to 12 further takeover targets.

That said, while the integration of Nationwide Autocentres continued as planned, the unit's underlying sales were flat in its first quarter.

However, in the long term, we tip the retailer, which is rebranding Nationwide Autocentres under the Halfords name, to become a powerful player in the car maintenance market, which is worth £9bn a year and dominated by independents. The consumer spending squeeze and end of the Government's vehicle scrappage scheme should see more motorists checking their cars into Nationwide Autocentres this year. This also bodes well for Halfords' We Fit service, which installs products such as windscreen wipers.

In addition to its progressive dividend policy, Halfords, which sells one third of the bicycles bought in the UK, has a growing accessories and camping business, which sets it up well for a challenging year ahead.

N Brown, which now trades on a 2011 p/e ratio of 8.79 – a tasty discount to the sector – is another retailer that has been on the acquisition trail recently. Following its purchase last year of High & Mighty, the plus-size retailer which had 14 shops, N Brown returned to the core focus of growing its online presence by snapping up the internet lingerie company Figleaves for £11.5m in June.

But the real long-term growth for N Brown will come from targeting the expanding waistlines of consumers in Britain and overseas, as demonstrated by the launch of its Simply Be range in the huge US market yesterday. Similarly, the burgeoning overseas business of Mothercare, which has a p/e of 13.3, is just one reason why many City analysts have the company's shares on their shopping lists. Like certain analysts, we also rate the diversity of Mothercare's wholesale business and its shift away from high street stores to cheaper out-of-town retail parks.

Elsewhere, the proven profitability record and strong roll-out programme of stores at Dunelm, which has a p/e ratio of 13.6, lends itself to investors looking for a relatively safe haven in choppy waters. The retailer will also benefit from a continued flight to value among consumers.

The year ahead may not be a great one for the retail sector, but talk of impending doom may have been overdone, as long as unemployment does not reach disastrous levels.

Brave investors may also want to cast their minds back to March when the fast-growing fashion chain Supergroup floated at 500p per share. Its shares closed at 1,000p yesterday after doubling in five months.