by Scott Krisiloff, CIO, Avondale Asset Management
Arguably the biggest story of this quarter has come late in the earnings season. Retailers are truly coming to terms with the massive challenges that the industry is facing. This isnât a new realization. CEOs have known this is coming for more than a decade, and they have spent at least the last five years heavily investing in âomni-channel.â But this is the first quarter where CEOs are recognizing that theyâre losing the war. Amazon is taking a larger and larger bite of retail sales every quarter, and because retailers have high fixed cost bases, every lost sale becomes more and more painful. This means that the process is likely to accelerate from here.
CEOs have to be optimistic for their shareholders, which is why investors have to train themselves to read between the lines. All of these CEOs are talking about seizing the moment and investing in new platforms. But the vast majority of these companies are trying to take hills that have already been lost (more than a decade ago).
For most of these companies, investing now is just throwing good money after bad, which is the antithesis of being a steward of capital. However, most of these CEOs are staring their careerâs mortality in the face, and when that happens its easier to go down with the ship than tell everybody to get into life boats.
There are some management teams who will tell you the truth and those are the ones to listen to. The only way to have a positive outcome is to see the playing field clearly and operate without bias. Adversity is what separates great management teams from weak ones.  Invest in great management teams.
The Macro Outlook:
Retailers canât hide from their problems
âOur industry is the midst of a seismic shift, and, of course, you read the headlines. In fact, many of you write the reports, weâre operating in an incredibly challenging environment. All across the retail industry, many of our competitors are aggressively rationalizing their assets. They are closing stores, exiting markets. Theyâre cutting costs just to keep their heads above water. Weâve not seen this number of distressed retailers since 2009 in the Great Recession.â âTarget CEO Brian Cornell (Retail)
Thereâs too much retail space in the US, especially in a digital world
âRetail square feet per capita in the United States is more than six times that of Europe or Japan. And this doesnât count digital commerce. Our industry, not unlike the housing industry, saw too much square footage capacity added in the 90âs and early 2000âs. Thousands of new doors opened and rents soared; this created a bubble, and like housing, that bubble has now burst. We are seeing the results; doors shuttering and rents retreating. This trend will continue for the foreseeable future and may even accelerate.â âUrban Outfitters CEO Richard Hayne (Retail)
Old empires are shrinking
âwe made great progress narrowing our geographic focus to North America. While we have successfully provided tremendous value to business customers across Europe over the years, we have not been as successful creating shareholder value in Europe. We believe itâs in the best interest of our shareholders to narrow our focus to North Americaâ âStaples CEO Shira Goodman (Retail)
Management teams are scrambling to build new platforms
âWe certainly view 2017 as a year of investment. In 2018, weâll continue to transition as these different initiatives begin to mature. As we get into 2019 and beyond, we certainly expect stability and a return to growthâŠWeâve got to invest to grow. Weâve got to reimagine our stores. â âTarget CEO Brian Cornell (Retail)
âwe plan to do what any good portfolio manager would. Invest resources in the most promising opportunities, diversify to lower risk, and increase liquidityâŠOur highest priority is where weâve had the most recent success, digitalâ âUrban Outfitters CEO Richard Hayne (Retail)
But they are still holding on to their old ones
âFirst, letâs talk stores, our key competitive advantage. They are at the center of everything we do for our guests regardless of how we deliver. The 40% digital growth we saw in December, they enabled it.â âTarget COO John Mulligan (Retail)
And although the economics of e-commerce are good
âto kind of call out the profitability of e-commerce versus the profitability of the store, weâre not ready to do that. But I will tell you that the e-commerce business is probably more profitable than you think.â âDicks Sporting Goods CEO Ed Stack (Retail)
This is worse than a zero sum game
âThis would be fine if the increase in DTC sales were wholly additive, but theyâre not. Digital shopping is partially replacing store shopping and thus is negatively impacting store traffic and store generated sales. Flat to negative store âcompsâ are causing occupancy deleverage and eroding four-wall margins.â âUrban Outfitters CEO Richard Hayne (Retail)
The positive is that this isnât the first paradigm shift for retailers
âthese inflection points come around every generation or so. And strong retailers endure, while others, well, they donât. Pick your era defining change throughout history from downtown department stores to suburban malls, catalogs, e-commerce.â âTarget CEO Brian Cornell (Retail)
And itâs a good time to pick up real estate if you can use it
âWe look at this going forward that now is absolutely the right time to be patient from a real estate standpoint, with all the real estate thatâs going to come up on the market. Penneyâs announcing stores that theyâre closing, Macyâs announcing stores. Some other people that are rumored to be closing stores or â consolidation in this industry is not over. And this is a time that weâre going to be very patient going forward.â âDicks Sporting Goods CEO Ed Stack (Retail)
Meanwhile, in other macro newsâŠ
Demand still hasnât caught up with sentiment
âIâm optimistic about some of the changes that we see more broadly in the environment but at this point in time thereâs nothing really thatâs quite happened yet. Tax reform is still a discussion, it hasnât occurredâ âVerizon EVP John Stratton (Telecom)
Inflation may not be as strong as advertised
âRegarding deflation, overall, primarily in the US, we have seen deflation in the 1%, 1.5% range in February. Departments such as foods, sundries, frozen foods, liquor meat, dairy showed the most deflation on the foods and sundries side. On the non-food side consumer electronics continue to be deflationary, primarily in the TV categoryâŠThe collective view is inflationary, or less deflationary, for the next few months and maybe a little inflationary, but itâs a crap shoot.â âCostco CFO Richard Galanti (Retail)
âwe also have to acknowledge the ongoing challenges facing our industry. Our customers are facing a difficult retail environment due to deflation and increased competition. We view deflation as cyclical, inflation will come back at some point but while itâs here, itâs leading to some very real challenges for us and our retail customers.â âUNFI CEO Steven Spinner (Food Distributor)
A border adjusted tax would probably change that quickly
âWe donât believe itâs good for consumers â itâs going to raise pricesâŠwe personally donât buy into the fact that it will be offset by a big rising dollar. We donât know whatâs going to happen with the retaliation out there by other countries, and weâll see. But as a retailer, we definitely think that itâs bad, and weâre against it.â âCostco CFO Richard Galanti (Retail)
Financials:
Housing markets are strengthening
âwe definitely are feeling a little strengthening in the marketplace and I think our sales per community, our contracts per community are certainly an indication of that. If I look around the country, Iâd say weâre feeling some strengthening, certainly in Northern California in the Sacramento area that has been strong. Weâre continuing to see a strong Texas market, the Arizona market in Bromley in Phoenix that has been strengthening as well.â âHovnanian CEO Ara Hovnanian (Homebuilder)
Asia leads the US in digital banking
âI would say that weâre most advanced in digital right now in Asia as you might suspect. And Asia kind of leads the U.S. and the U.S. certainly leads MexicoâŠIn Asia, if you didnât have a great digital offering you would be dead. And clearly, the way the U.S. is going thatâs the same way it is.â âCitigroup CFO John Gerspach (Bank)
Consumer:
Digital spend is now 55% of Home Depotâs marketing budget
âYou might be surprised to know that a better part of 55% to 60% of all of the marketing that we deployed now is in the new media or digital worldâŠvery active with Google search termsâŠvery active social media practice. We do a lot of retargeting for customers and are constantly looking at ways to make our marketing and advertising more personalâŠand also more location aware. So, talking to you based off the weather patterns that youâre experiencing in your local neighborhood, those are all things that we have and weâve deployed in our marketing spend.â âHome Depot CMO Kevin Hofmann (Retail)
âCelebrityâ is a commodity with rising value
âIn January to broaden Revlonâs social reach and digital relevance we announced the signing of Gwen Stefani as our new global brand ambassador and four new digital influencersâ âRevlon CEO Fabian Garcia
Technology:
5G will change the architecture of the telecom network
âthe reinvention thatâs required has surprised usâŠRF design is a really critical point. Weâve run and managed and design these networks a certain way for 20 years and the 5G paradigm is completely different. I think thatâs going to surprise some people.â âVerizon EVP John Stratton (Telecom)
5G requires more small cells
âitâs going to require a lot of small cells, lot of space, lot of power, a lot of backhaulâŠit doesnât propagate walls very well, or trees or other obstacles and so we think there is going to be â in order to get it effectively into the home and an antenna is required to be mounted on the house to get the propagation through the house thatâs required.â âComcast Cable CEO Neil Smit (Media)
It probably wont be deployed on mobile until 2020
âmaybe the end 2019 into 2020 where you might see the first sort of delivery of mobile based 5G. And remember also to scale you have to seed the base of handsets and so youâll have that curve. Thereâs a cost curve, thereâs an initial integration that needs to happen.â âVerizon EVP John Stratton (Telecom)
Industrials:
Connected cars generate a lot of data, but who owns the data?
âthere is an awful lot of engineering resources going in where the OEMs realize the vast amount of data that they could provide, how do they want to collect it and how do they want to retain it and how they want to process itâŠOne of the things we have to remember is that the customer owns the car. And so the data coming off the car belongs â I think most people feel belongs to the customer.â âSirius XM CFO David Frear (Telecom)
Miscellaneous Nuggets of Wisdom:
If you optimize your business for any single metric it should be Net Promoter Score
âwe put in one measurement system, Net Promoter System and everyone is measured on that and paid on that including Brian and myself. It focuses on what the customers want and need, and whether they would promote your service to a friend or family, and we also have an employee NPS score, which gets the feedback of the employees who are fundamentally trying to service the customer. So itâs been a real morale lift for the employees.â âComcast Cable CEO Neil Smit (Media)
Youâre better off paying a fair price for a healthy company than a low price for a dysfunctional one
âwe typically donât like to acquire turnarounds or companies that are financially troubled. Weâd rather pay a fair price for a company thatâs doing well than a very inexpensive price for a company thatâs not doing well.â âUNFI CEO Steven Spinner (Food Distributor)
Full transcripts can be found at www.seekingalpha.com
Copyright © Avondale Asset Management