The holiday shopping season is usually the most wonderful time of the year for retailers. Over the past few years, however, it’s brought attention to the mounting pressures traditional retailers face on their business model. The continued adoption of online shopping and the proliferation of off-price retail concepts continue to chip away at full-price, brick and mortar market share—at an accelerating pace. This may present potential opportunities for investors, but we advise a high degree of caution.
Why Are Full-Price Stores Languishing?
Department store closures have recently grabbed headlines, but off-price, factory outlet and online retailers continue to expand capacity. Over-building by traditional retailers has forced many market participants to rely on greater and greater discounts to drive growth, ultimately deflating what customers are willing to pay for retail goods. The rise of fast-fashion and more volatile weather patterns also make it harder than ever to optimize seasonal store inventory, and increasingly price-conscious consumers are less willing to pay full price for anything other than the most exclusive brands.
When consumer demand forecasts go awry, more excess inventory becomes available for off-price retailers to buy and flip at a deep discount. Online retailers, while lacking the off-price “treasure-hunt” experience, provide an additional low-price channel with the convenience of free, two-day shipping. These two alternative retail channels reinforce consumer perception that “full-price” is “over-price” and anything less than 40 percent off isn’t worth the trip.
Market Transformation Creates Investment Opportunity
Structural transformation in any industry opens windows of investment opportunity, but can also create value traps—stocks that appear cheap but whose fundamentals may be in a state of permanent decline.
We believe stocks worthy of investment consideration need to be not only high-quality franchises that are temporarily out of favor, but also on the right side of secular trends:
- Low-cost providers that benefit from a discount culture with logistics infrastructure advantages
- Big box retailers, warehouse/club stores
- Niche product categories that are more insulated from online competition and structural deflation
- Home improvement, auto parts, pharmacies, grocery
- Owners of strong, recognized brands that can reach consumers through multiple channels
- Truly differentiated apparel/accessory brands, toy makers, durable goods brands
Within these buckets of higher quality businesses, we look for clear visibility of improving fundamentals and/or overdone negative sentiment. Attractive opportunities may take the form of an auto parts retailer going through a disruptive merger that should eventually come out on the other side with much higher profit margins; a big box retailer with especially large scale whose assets have become enormously underappreciated due to the stigma of owning physical stores; or a universally known apparel brand that has become over-distributed but stands to benefit from product rationalization and supply chain improvements under a new management team.
Corporate turnarounds are very hard in highly competitive sectors, and the inherent fashion/trend risk in retail makes out-of-favor stocks have a much wider range of outcome investments than in other sectors. For that reason, keeping an eye on long-term, secular trends—in conjunction with taking a traditional, bottom-up approach to company analysis—is especially important when evaluating opportunity in the retail industry.
Investment Professionals: For more information on this topic, download
“Retail: Thinking Outside of the Brick and Mortar”. (Requires Log-in)
The opinions expressed are those of Paul Howanitz 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.