Monday, January 14, 2013

The Outlook For Retail in 2013?

I’m in the process of looking back at 2012 and speculating on what we might see in 2013. The New Year is always a good time to pause and reflect, even if it is just another day.  I don’t think any other sector has been more fascinating than retail and particularly with regards to the US. The dynamics of the retail sector are very different in this recovery.

A Very Different Recovery

Whenever Rocky Balboa was set to recover from a knock down all he needed to do was put together a 4 minute montage of himself running up a the Art Museum's steps, punching slabs of meat (Wiener schnitzel anyone?) or bench pressing the weight of Paulie’s lunch bag. Alas in the real world it’s not so simple and recoveries take time. This has been a uniquely difficult recession for Rocky’s blue collar friends as this graph demonstrates.

This x axis is the number of months from when the US economy started adding jobs again from a recession. The data is total payroll employment from the Bureau of Labor Studies.

This has been an incredibly anemic recovery from a nasty recession. Jobs growth has pretty much tracked previous recoveries but is nowhere near what it needs to be. The US has barely recovered 50% of jobs lost and it’s in the 33rd month of recovery. The economy has taken longer to recover than it took me to get over the death of Mickey in Rocky III. And that is saying something although, in truth, I'm not really fully over the trauma of it all.

Trading Down

The point is that the mass consumer market in the US has been very tough even as the high end has recovered well. This has created some unusual dynamics and shifted sales channels of many fast moving consumer goods companies. The discount stores and off-price retailers have been key beneficiaries of the new retail reality but the market has not been slow to price this in. I think prospects look good but the stock prices are a bit out of step with the fundamentals right now.

The discount stores continue to aggressively roll out new stores even though the likes of Dollar General (NYSE: DG) have been reporting weaker same store sales numbers lately. The problem that the dollar stores have is that the incumbent groceries like Kroger and Safeway are starting to fight back. Should DG continue expanding at this pace?

Changes in footfall and shopping habits also change the products that the mass market is buying and this has caused no end of problems for FMCG companies. Suddenly everyone wants in-store brands and private label options, smaller portion sizes and even the traditional sales channels are shifting.

For the likes of Procter & Gamble (NYSE: PG) this has produced challenges to their operating model. In the US the FMCG companies seem to be locked in a never ending cycle of price reductions/promotions/marketing leading to volume gains followed by an attempt to increase prices, which then fails and volumes go down again and so on. No matter, many of these companies pay a decent yield so the market is rewarding them. However should bond yields rise do you really want to be holding a low growth FMCG company?

You are Special but I Have a Third Woman

While the mass market is suffering, the specialty market is doing really well. Consumers are increasingly buying commoditized products online but seeking lifestyle defining differentiation through specialty stores. Long-term trends with increases in divorce, the legal system working in women’s favor, and the pernicious combo of feminism and hypergamy are all seeing the rise of a wealthier older single woman and she is spending accordingly. I find it incredible that Whole Foods Market (NASDAQ: WFM) can be talking about the 80/20 rule in their business. In other words 20% of its customers are generating 80% of its sales. As a grocery store this implies that there are some uber shoppers out there who are significantly impacting retail trends.

My guess is that there is a significant crossover here with Whole Fooods' uber shoppers and those of yoga gear manufacturer Lululemon Athletica (NASDAQ: LULU), which as I argue here has some very strong trends behind it but also has an evaluation that can only be peacefully accommodated after a significant amount of yoga sessions. In the end they make athletic wear and why this is special is beyond me, but then again I don’t understand why anyone listens to rap music but they do.

While discount and specialty retailers are on the rise we shouldn’t see them as separate. Indeed I think a ‘third woman’ exists. She shops in the discount and off-price retailers so that she can save money to go and buy in the specialty stores.

So What Will Be Hot in 2013?

At some point the discount retailers may get cheap enough to buy but they will probably have to disappoint the market some more first. I like the off-price retailers like TJX Companies and Ross Stores because I think they have a more differentiated offering and some upside from their home ware offerings.

In general, housing related retail is set to continue to do well.  Home Depot’s evaluation provides for good upside and something like Williams-Sonoma (NYSE: WSM) has good exposure to a recovering US housing market plus growth prospects from international expansion and new concept stores. More on the company here.

In summary, I think the economic recovery will continue at a slow pace but there is upside for some sections of retail. Housing will continue to do well and the specialty store (not the faddish type stocks like say Crocs or Abercrombie & Fitch) may well surprise on the upside. FMCG looks okay but investors need to be selective.

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