Retail: it’s not all doom and gloom
Harry Smith, Senior Investment Analyst
10 April, 2018
Almost daily we see articles discussing store closures and retail being doomed in the US, pronouncing the death of the US mall. The cause is often attributed to the formidable force, which is Amazon.com. So given this environment, which has most recently seen Toys-R-Us liquidate, does it make brick and mortar retailer's uninvestable?
In short, our answer is no. In fact we see pockets of growth in the current environment. For example, TJX, the Briscoes of the US (but in branded apparel). But before we get into specifics, let's take a step back and take a look at what is actually happening with US retailers at a time when consumer confidence and spending has been robust.
Pressured by Wall Street expectations, many retailers have expanded their store foot print well beyond sustainable levels. For example US malls have grown four times faster than population growth since 1975. As a result, there is a significant amount of overcapacity in many segments of retail, especially given the rise of many other pressures since the Global Financial Crisis (GFC), which we list below.
Consumers, particularly millennials, are increasingly valuing experiences over physical things. Therefore, spending on services has been outpacing spending on physical goods, which doesn't bode well for traditional retailers.
There has been a steady increase in subscription-based services (examples are Netflix and Spotify), which means a greater proportion of weekly disposable income is already committed before a brick and mortar retailer has an opportunity to entice a consumer to spend in their store.
Inequality has increased. The majority of the US working population has not seen their inflation-adjusted incomes increase. These same individuals have seen the cost of non-discretionary expenditures (such as health care, housing, child care, and education) rise.
Lastly, there is no doubt e-commerce has had a large impact on traditional retailers. We estimate that when a brick and mortar store closes, one-third of its sales moves online. Also, e-commerce is taking a disproportionate share of retail sales growth.
So, we are left with a paradox. Consumer spending and confidence is strong and consumers are benefitting from low interest rates. At the same time, though, retailers are closing stores at historic rates.
This paradox, and the explanatory factors cited above, create an increasingly tricky environment for investors in consumer stocks. On the flipside this complexity creates opportunity, which brings us back to TJX an ‘off-price’ retailer, which has benefitted from an oversupply of inventory as stores close, rising inequality making consumers more value conscious and a business model that is hard to replicate online.
TJX sells branded clothing, such as Nike and Ralph Lauren at a 20%-60% discount to a full-price retailer. They can sell inventory cheaper than other retailers as it sources stock from store closures, order cancellations and manufacturer overruns, which have been plentiful since the GFC, allowing them to sell at a significantly lower price.
In store, a wide assortment of inventory turns over quickly, but there is little depth in terms of sizes etc. This creates a ‘treasure hunt’ experience, encouraging customers to visit stores regularly as new and different brands arrive almost daily. It is also a model that is hard to replicate online given your ability to view numerous items.
We bought TJX as we believe the company has a good growth runway for new stores openings and in our opinion can also continue to consistently grow sales at existing stores. If we are correct, TJX should grow its earnings at close to 10% per annum, while paying a steady and increasing dividend. The company has longstanding management team with a track record that is hard to fault.
Despite having solid growth prospects. TJX's valuation has been depressed given market concerns about the broader retail sector, thereby presenting an opportunity.