THE BIG PICTURE
It’s conference season – especially in Retail (back to school, Holiday approaching, etc…). That’s when CEOs of the biggest and baddest (literally) US retailers strut to Downtown NYC, Boston, or Nantucket. They flash their pearly whites in front of hundreds of people, then retreat to the "secret meeting" rooms most of you are not invited to share their real, uncandid thoughts about business. This is so bad, in so many ways, and has been core to how so many money managers have generated Alpha in the past.
But let’s be clear about something. You should be glad not to be invited to what I think is an egregiously clubby hot mess. Why? The information is simply wrong. It's maybe 75% accurate on the upcoming quarter (TRADE duration). 50% accurate on the year ahead (TREND). And it’s at best 25% right over one to three years (TAIL). Many investors we respect are increasingly not even showing up at these things anymore. The groupthink is pervasive, and the groupthink is often wrong.
Why, you ask, can these vaunted CEOs be wrong? The management teams give the impression that they have a crystal ball. They don’t. The same could be said about the Fed. The irony here is that the Fed is increasingly using Wall Street as a source of information. Wall Street looks to companies (and the Fed) for information. Companies look to what the government is selling this week, and what they hear from the competition (through Wall Street). It's a circular cesspool of despair.
The end result, I think, is the best opportunity in nearly two decades to make money. We keep hearing, “it’s such a tough environment. Hard to make money in this tape.” That is true, if you aren’t looking through the groupthink, or you don’t have a process to game it over the near term. Don’t get me wrong. I’ve had some lousy calls in 2016. But I’ve had more good ones, and will have even more by year end. #process always wins.
RETAIL MACRO GRIND
Here’s one of the biggest opportunities to make money in Consumer Discretionary today. Let’s start with Retail Sales – in the context of what really matters.
• We have an $18 trillion economy.
• $13.8 trillion in disposable income.
• $12.7 trillion in consumption capacity (72% of GDP -- which is almost always maxed out).
• ‘Only’ $5.5 trillion of that makes its way to Retail Sales.
• Further, the GAFO category (General Merchandise, Clothing, Electronics, Home, etc…) is only $1.3 trillion.
It’s the GAFO category that’s represented by the sales and earnings reports of companies like Target, Home Depot, and Gap. There’s a perception that Retail Sales compares vs 2H15 are easy this year, and that’s actually true. Retail Sales growth slowed by 20-30bps in each of the last three quarters of last year. But that’s the $5.5 trillion number. The GAFO category, the one that’s representative of companies that report earnings, actually strengthened by 20-30bps over that same period. In other words, the Retail Sales comparisons for the data set that actually matters get tougher from now through year end. Ignore the groupthink. Short the MVR.
But here’s the real trend that’s being obfuscated by those pearly whites – and that’s the impact e-commerce is having on the economics of the retail supply chain. “Yeah, thanks McGough, people are shifting spending online…thanks for that #newsflash.” Got that.
What people don’t know is that e-commerce is accelerating off of a larger base. Consider this… online stores/marketplaces (like Amazon, Wayfair, etsy and even eBay) gained 263 basis points in share of retail sales over the past three years. That’s pretty huge given that it came off a base of only 7.6%. Keep in mind that the 180bps lost by a category like GAFO actually includes its own e-commerce sales. In other words, the share loss to online on the part of Kohl’s and Target came despite all their talk of growth opportunity in e-commerce when they are working the one-on-one circuit.
Here’s the kicker – of the 263 basis points in share gain for e-commerce, 177bps of it came over the past 12 months. That sentence might be worth rereading. It’s huge, and I can assure you that no self-respecting brick & mortar CEO is taking about that. Those that are probably are on their way our [case in point – HBI’s CEO has 16 days left on the job. Macy’s has 108]. Those guys know the drill.
But here’s what really matters. Most of these companies, HBI, TGT, KSS, LULU, FL, JWN, BBBY, BBY, TIF, JCP, WSM (I could go on) are all woefully underinvested in dot.com. Their current throughput in their D.C.s is near peak, and yet the e-commerce business simply can’t grow at a sustainable and profitable clip. That means they continue to suffer top-line misses, or meaningfully up investment spending and take earnings lower.
This is not to say all companies are doing it wrong. In fact, many of them, like RH, are perceived to be screwing up – and while they have had some painful self-inflicted wounds, the reality is that are leaning when others withdraw. That’s how you win a joust. Who else is doing that? WMT, NKE, and even DKS.
We’re about to enter a period (2017) where earnings/margin bifurcation should blow out between quality management teams and the junk. We’re modeling more companies than ever putting up 20%, 40% and even 60% earnings misses. Others will beat by the same magnitude. This is one of the biggest opportunities to make money in Retail equities since the dot.com bubble burst a decade and a half ago. Remember? 80% of the ‘new economy’ ended up being a really bad idea and subsequently crashed and burned. The other 20% blew out expectations and became the next Amazon.
Welcome to Retail 2017.
Have a great weekend.