Why I like retailers
and why I am wary
Shopping is a deeply embedded part of American culture. The great holiday retail season is upon us. But this is an industry driven by trends and fashion, which can be hard to model with financial tools. People are going to shop, but where?
Amazon and Costco have their own lanes
The low switching costs that most consumers would pay for shopping at a competitor are a worry for most retailers. So first of all, can we find companies that don’t have much competition in their niche?
My picks for the retailers with the clearest lanes are Amazon (AMZN) and Costco (COST). While many other companies sell goods online, Amazon is a massive whale in that space that just has an enormous lead at this point. As the only retailer that also clearly qualifies as a Big Tech giant, Amazon brings big profits from its AWS web hosting division while keeping costs low on its retail side—an extraordinary market advantage. In addition, the massive trove of purchasing data generated by running Amazon gives the company a lead in creating its own products (“Amazon Essentials,” etc.) while its marketplace allows it to act as a massive drop shipper with small store owners fulfilling many if its orders as Amazon still gets a cut. Costco is also a clear leader, but in the warehouse club store category. While many stores have struggled with supply chain issues, Costco has kept its stores well-stocked recently (even if they have had to limit toilet paper purchases to 1 per customer in some locations). The current round of inflation has seen many retailers looking to raise prices and Costco’s consistently low prices as compared to competitors leave it room to raise while maintaining its low-price image with consumers. Other warehouse stores, including Wal-Mart’s Sam’s Club, just don’t have the same nationwide scale to compete on the same level. So Amazon and Costco are two stocks that I would recommend based on their overall performance and also their market power.
The Big Box space is okay
Wal-Mart (WMT) and Target (TGT) as a pair are quite dominant in the consumer big box store category. Old rivals like KMart are moving slowly toward oblivion, and these two have become the main “superstore” players in America. But while Target is up over 30% in the last year, Wal-Mart is down slightly. Even as the 5 year returns for both of these retailers are quite good and they both have a strong position in the market and growing online sales, I have an expectation that they should grow going forward at close to the overall market return rate. Could it be more? Very possibly. But superstores seem like a mature market and I don’t see enough reasons to go and acquire shares of these two right now.
The Dollar Store category is interesting
While plenty of new 98-cents stores and such are popping up in towns across the country, the “Dollar Store” category has two large corporations, Dollar General (DG) and Dollar Tree (DLTR). Dollar General has seen fairly steady growth in share price over the last five years, while Dollar Tree was flatter until a jump up lately with good results and news that they were raising their prices to $1.25. Both retailers offer small and inexpensive items including decorations, food, drinks, household and cleaning items, and novelties. But while Dollar Tree (and their Family Dollar division) is heavily concentrated in strip malls in suburbs and common on the West Coast, Dollar General has many locations in small towns and rural communities in America’s interior and East, sometimes replacing old Big Box stores as the main outlet in an area when they leave. These differences in locations and demographics show the popularity and resiliency of the Dollar Store concept. Both companies might be worth a look but Dollar General could well have the more unique niche going forward.
Hardware stores are booming
The activity in home construction and re-modeling has been vigorous in the last few years, in line with a hot housing market, and that means that the places that sell tools and materials to consumers and small businesses are doing great. Home Depot (HD) and Lowe’s (LOW) have both seen sharp rises in share prices in the last year, as supply chain disruptions ran headlong into high demand and led to a remarkable spike in the price of commodities like lumber. The costs will go up for the retailers too but probably at a lower rate than they can raise prices, and meanwhile they are holding massive amounts of inventory while its price increases. Of the two, Home Depot is the larger one and was traditionally the one I saw as the better bet: it seemed to have some advantages in terms of scale and very few disadvantages. However Lowe’s has seen very strong performance lately and their CEO Marvin Ellison is committed to diversity as a strategic benefit rather than as a buzzword and the results so far speak for themselves. Both are worthwhile investments but my excitement level right now is a little higher around Lowe’s.
Grocery stores are somewhat in flux
Disruption is happening in the food and dining space, as a result of the pandemic and due to changes in consumer preferences. Smaller specialty and fresh food stores are a growing segment and while some of them are co-ops, some are corporations with public shares. One of these is Sprouts Farmers Markets (SFM), a premium grocery retailer with numerous locations on the West Coast and Arizona and several on the East Coast and through the South. Profitable and trading at a P/E around 11, Sprouts is an interesting play on the fresh grocer sector. Whole Foods, owned by Amazon, is worth consideration because of their consistent premium pricing power. But the other grocers have also done well lately: Kroger (KR), which also owns Fred Meyer, QFC, and numerous other brands, has seen a 25%+ return on its share price in the last year and is profitable even if it has a less enticing P/E of around 28. Albertson’s (ACI), a recently re-organized company that owns a number of grocers including Safeway, has seen its share price more than double in the last year. In addition to other grocers, these companies have to compete with food delivery services and big box stores, which sell a very large percentage of the packaged food consumed in America. So while the companies mentioned are worth a look, the range of competitors arrayed against them suggests a level of caution here.
Drug stores face uncertainty
The last five years have been mixed for drug store giants CVS Health (CVS) and Walgreens-Boots Alliance (WBA). The last five quarters saw such good performance for main street mainstay CVS that they were enough to leave them up on the 5 year chart. Walgreens-Boots, the Anglo-American holding company for stores of the same names, has had a less good (but at least up) year while the 5 year chart is down 45%. While both companies offer a value play with the kind of chart that some of those kind of investors like to go with each having a P/E of around 16, I am not sure if drug pricing is very predictable going forward or whether these stores offer a compelling selection of everyday items compared to their many competitors, including big box stores also offering drugs. So I think I will stay cautious about taking new positions in the drug stores for now.
Pet supply stores have cooled off
Chewy (CHWY) is a fairly new online pet supplies store, while Petco Health and Wellness (WOOF) is a new stock from this January even if it has been a well-known retail store for a while. Both have dipped about 9% over the last year, whereas Chewy had a pretty fast run up before that and still sits up 96% from its debut in June 2019. So did it run up fast and now just faces a temporary correction? That’s my best guess, as I think the online market for pet food and toys will continue to grow. Petco has online sales too but is still known mainly as a physical store—this has led to some concern about their labor costs, which are an issue for every single one of these companies but may be acute in the specialized pet grooming market.
So is the pet retail sector worth getting involved in? I would advise holding these companies for now. No reason to panic, it just might take a little longer to ride out what appears to be a little bear market in this corner of retail.
Online Marketplaces are taking off
Small businesses looking to sell items online have a lot of choices. Some of them set up their own store with cloud software, while some go to online markets created by companies like eBay (EBAY), Etsy (ETSY), and Amazon. These companies all do things a little differently but individuals and small businesses can use each of them to sell items—while traditionally many people associated Etsy with homemade goods and eBay with auctions, both now allow creators to sell a range of different goods (while Amazon’s seller program and “Amazon Handmade” allow similar activity on Amazon’s site). Both eBay and Etsy have seen excellent results in the last year, up 40% and 75% respectively. This sector has plenty of room for growth for numerous players but I especially like Etsy because I think they weathered the cloth mask boom-and-bust cycle and, very likely, retained many of those customers who may have moved on from pattern masks but now want prints, pins, and other items from some of the same artists and creators.
Retail success is unpredictable and fleeting
With the growth of the giants and the consolidation of the sector, American retail stocks are now concentrated heavily as far as market capitalization in a few mega-corporations (Amazon, Home Depot, Wal-Mart, Costco). But these corporations have managed to deliver consistent profitability on the way to pushing traditional powerhouses like Macy’s (M) to the relative margins of the discussion. But like Sears and Woolworth and other powerhouses of the past, every retailer seems to fade eventually and part of the game is calling the top, or close enough, and selling so you can move your investment over to the next big trend.
Disclosure: Through personal holdings that I control and through investment LLCs in which I am a partner, I buy, hold, and sell stocks, bonds, ETFs, options, and cryptocurrencies, not limited to but including some of those discussed in this newsletter.