The secular trends toward online shopping and off-price retailing are disrupting the space. As the new normal for retailers evolves there will be winners and losers—rewarding those with strong security-selection processes.
Secular Trends Are Disrupting Retail
Some might believe that macro factors, such as concerns about China’s economy, worries regarding Brexit and tensions over the Federal Reserve’s struggle to incrementally raise interest rates are partially to blame for the business challenges of retailers. While we understand how these factors can influence equity markets in the near term, we believe that retailers are facing unprecedented secular trends in how and where people buy tangible goods.
Excessive Retail Capacity Provokes Discounting
Since 1995, the number of shopping centers in the U.S. has grown by more than 23% and GLA (total gross leasable area) by almost 30%, while the population has grown by less than 14%. Currently there is close to 25 square feet of retail space per capita. In contrast, Europe has about 2.5 square feet per capita.¹ This has led to discounting, predatory pricing, and a deflationary effect on the prices of retail goods. Once-stable department stores Nordstrom and Macy’s have ramped up brick-and-mortar off-price locations, creating pressure on returns of invested capital and potentially harming their respective brand reputations.
Shoppers Covet Convenience
Online shopping accounts for about 12% of all apparel and footwear sales in the U.S., as compared to about 1% in 2001. Market leader Amazon holds about 16% of apparel and footwear sales.² Time-pressed consumers cherish convenience in all channels, with online shopping arguably being the ultimate in convenience for millennials entering their prime spending years. Notably, technology is driving the integration of online with brick-and-mortar retail, requiring traditional retailers to compete with the likes of Amazon.
Transformation Creates Opportunity for Value Investors
Periods of immense structural transformation in an industry such as retail opens windows of opportunity and value traps. However, the momentous technological and social shifts causing transformation present greater risks than usual. As value investors, we prefer stocks of companies that are temporarily out of favor. In a transformational situation, we must even more carefully assess the future of a given retailer. Is it adapting to the times? Does it have the financial strength to implement the necessary changes to survive? Will consumers buy into its new way of doing business?
Walmart, for example, is an established retailer that is working diligently to adapt to the changing landscape. Better training and compensation for employees, investments in online operations, and updating stores can all potentially drive sales, customer loyalty, and stock appreciation. Lowe’s, on the other hand, is a specialty retailer that is somewhat insulated from secular trends since consumers generally find it advantageous to physically visit its well-stocked and smartly merchandised stores. Lowe’s also benefits from a cyclical tailwind in which sales are largely driven by consumers’ spending on their homes.
One Retail Stock at a Time
Consumers are consistent in that they constantly change their preferences for style and shopping experiences. The process we follow to determine if a stock has unlocked value does not change, regardless of market volatility or macro trends. Each company is carefully evaluated in a bottom-up approach while also acknowledging long-term, secular trends that may help us determine the winners and the losers. This is especially true in the retail industry.
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Q3 2016 CIO Insights: Separating the Winners from the Losers in Retail
¹Robin Lewis, “Retail in 2015: A Reality Check,” Forbes, March 17, 2015.
²Anne-Charlotte Windal et al., “The Long View – U.S. Perspectives, 2016 Edition,” Bernstein.
References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.
The opinions expressed are those of Phillip N. Davidson, CFA, and are no guarantee of the future performance of any American Century Investments portfolio.
For educational use only. This information is not intended to serve as investment advice. Past performance is no guarantee of future results.