- E-commerce is disrupting traditional retail and continues to expand with a sales growth rate of 14% year-over-year.
- AMZN / WFM exemplifies how the retail landscape is shifting – SHLD exemplifies the hardships of a restructuring.
A new age of consumer spending has seemingly taken some of the retail sector by surprise. Brick and mortar stores are battling a time where 95% of Americans are within arm’s reach of their smartphone 24/7 and e-commerce sales are consistently growing at a rate of 14% year-over-year.¹
Are statistics like this only the beginning, or are concerns overblown? To find out, investors should start from the top.
The Macro Retail Environment
There is no question that the Internet is a key player to any modern omnichannel sales strategy. However, according to the St. Louis Fed, surprisingly enough, e-commerce retail sales as a percentage of total retail sales currently stands at 8.5%, per the latest quarterly update in May 2017 – The pervasiveness of this trend and its aforementioned growth rate is concerning to players who haven’t gained a foothold in this channel yet.
E-commerce has penetrated retail sales in a material way, but in some sectors more than others. According to sector analysis broken down by the North American Industry Classification System in the latest US Census Bureau’s Annual Retail Trade Report, the “electronic shopping and mail-order” sector is dominated by e-commerce; where online sales drive 68% of total sales.² Within this sector, we have online behemoth Amazon. Interestingly enough, Amazon is reported to power 43% of the American online retail market in 2016, according to Slice Intelligence.³ The use of robotics including cloud, industrial automation, virtual service and machine learning has transformed the way retail operates and performs. Companies on board with this shift and adopt new innovative ways early on, will thrive as we enter a new technology era. While others that maintain their traditional ways will soon be pushed to the side and forced to seek alternatives such as going private or closing their doors.⁴
The Census Bureau’s report also notes that “non-store retailers” have 58.1% of their sales driven by e-commerce. Other sectors like “motor vehicles /parts dealers” and “sporting goods, hobby, book, and music stores” have room to take share. These two fields only drive 2.7% of total sales via online mediums.
Given the importance of this trend, one would imagine that companies publish online specific data. But this isn’t always the case. Nearly all retailers have an online strategy, but a surprising amount of companies don’t actually disclose the composition of their sales figures – i.e. what percentage of sales are driven by online vs. in store. Management in these companies argue that the integration/tag-team effort makes their sales homogeneous. For example, a customer might select to pick up an item in the store after reserving it online or as Macy’s put it in their latest conference call, “it is almost impossible to truly break out digital from store, given all of the cross-channel activity. If somebody is using a mobile phone in store, having just worked with a sales associate, is that store or digital?”⁵
With this in mind, the investment community values detail and skipping this metric might suggest online sales are weak or the company is not diversified enough and at risk if consumers change their buying habits for a particular store. On the upside, if companies are more geared towards online sales, perhaps the market will assign them a higher multiple – as it’s more of a technology play than traditional retail trying to get online.
A quick review of stocks near their 52-week high or low shows investors value transparency. Some of the best performing retail stock like Best Buy Co Inc. (BBY) and Ulta Beauty Inc.(ULTA) disclose specifically their share of sales that are driven from online efforts, while firms like Macy’s Inc. (M), Zumiez Inc. (ZUMZ), and Bed Bath and Beyond Inc.(BBBY), have suffered lately and don’t disclose.
But putting up an online store isn’t the quick and easy solution. Investors will note that there is a trade-off where execution matters, as the CEO of Bed Bath and Beyond suggested on their most recent conference call. As the “digital business becomes a bigger portion of our business, and we continue this growth, those numbers in and of itself will turnaround but the reality is that we are historically a brick-and-mortar operation that seeing less foot traffic and that’s a hard thing to make up.”⁶
The bifurcation in retail is great for portfolio managers. The ability to analyze a security and for it to trade based on its own fundamentals – as opposed to the macroeconomic environment – is ideal. As such, there are many opportunities to identify select stocks with positive and negative themes.
For example, one of the longtime lagers in retail has been Sears (SHLD). As displayed below, the entire capital structure of the company has been under pressure. The stock slid 20% since November of 2016 and so have some of the bonds – for example the issue due 12/15/19 at an 8% coupon is trading down 14%, while the borrow rate (the cost to short) has climbed 128% to 92%, as displayed below courtesy of Interactive Brokers.
Sears has been the posterchild of underperforming retail and operational troubles. The company is closing stores and restructuring to adjust to current trends and avoid collapse. To expedite a hopeful turnaround, the company plans on closing a total of 270 locations this year, bringing their total count to about 1.2k locations, but creditors are skeptical. Just this year, Moody’s downgraded SHLD bonds to Caa2 – a rating deep in junk status.⁷
One of the most profitable categories for Sears is what they define as “hardlines”. According to the Sears 10-Q, this category “consists of home appliances, consumer electronics, lawn & garden, tools & hardware, automotive parts, household goods, toys, housewares and sporting goods.”
For every winner in retail there is a loser, and interestingly enough Home Depot (HD) seems to be responsible for some of the Sears lost share. In Home Depot’s latest Form 10-Q, they reported that, “comparable store average tickets increased 3.9% for the first quarter of fiscal 2017, due in part to strong sales in big ticket purchases such as appliances.” The rise of Home Depot in categories that Sears operates in – like lawn & garden, tools & hardware, can certainly add pressure. On the topic of sales, HD reported a 22.8% increase in online sales for Q1 2017 vs. the same period last year, and noted that online was 6.6% of total sales for the quarter. HD is only a few points off its all-time high.
Conclusion – Be Nimble as the Landscape Shifts
In Marc Andreessen’s Wall Street Journal article, Why Software is Eating the World, he suggests “the world’s largest bookseller, Amazon, is a software company — its core capability is its amazing software engine for selling virtually everything online, no retail stores necessary.” He is certainly right, but Amazon has larger ambitions than just “everything online” according to their latest acquisition proposal.
In a deal that is expected to close in the second half of 2017,Amazon will be entering the traditional brick and mortar retail grocery business, but for untraditional reasons.⁸ Analysts are predicting numerous synergies between Amazon’s high tech AI driven platform and Whole Foods. The combo will be serving up a dedicated customer base in 3 countries, perhaps via frictionless checkouts on the Amazon app and in-store pickup of staples in addition to perishables and other Amazon purchases. Speculation is rampant and only time will tell. The only definitive takeaway is that the retail landscape is changing before us as consumers leverage the conveniences of modern day software and internet access.
When all else fails, leave
A growing trend has been taking retail businesses back private. A few stocks are currently considering or have been rumored to consider removing themselves from the public market altogether. Nordstrom (JWN), for example, recently announced they were exploring going private.⁹ Additional clothing retailers like Abercrombie & Fitch (ANF) and American Eagle Outfitters (AEO) are being forced to close stores due the vast shift to online shopping. Both are still preliminary, but the idea that public markets are undervaluing retail is a concern for CEOs who need to maximize shareholder value and gain traction online.
- Conner, C. (2016, March 24). Fifty Essential Mobile Marketing Facts.
- Census.gov U.S. Retail Trade Sales- Total and E-commerce: 2015-2014.
- Cassar, A. K. (2017, February 01). Echo turns up the volume on Amazon’s ambitions as audacious bets pay off.
- Deloitte Industry Insights. 2017 retail, wholesale and distribution industry outlook.
- Macy’s Inc. Q1 Earnings Summary. (10-Q). May 2017.
- Bed Bath & Beyond’ s. Q1 2017 Earnings Call Transcript. June 2017.
- Moody’s Investors Service. Moody’s downgrades Sears Holding Corporate Family Rating to Caa2.January 2017.
- Whole Food’s Market Investor Relations. Amazon to Acquire Whole Foods Market. Press Release. June 2017.
- Nordstrom. Nordstrom Announces Exploration of Going Private Transaction by Nordstrom Family and Formation of Special Committee. June 2017.
Elite Wealth Management Team
Full Disclosures: http://elitewm.com/disclosures/
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