Back in the 1980’s and 1990’s, it was common on Fridays and Saturdays to roll down to the nearest Blockbuster and rent a stack of movies or video games for a cold winter weekend. I mention that practice to kids today, and they give me this puzzled look — why would they do that when they can watch movies online through Netflix, Hulu, or Amazon with just a few clicks?
Since then, Blockbuster failed to adapt to the marketplace, filing for bankruptcy in 2010 and, while a few stores still remain, has mostly faded away with the likes of drive-in movie theaters.
Our question for today: Are many retail stocks on a similar path to obscurity, or will they adapt and find a way to prosper? Stated another way, is the recent decline in the retail sector a systemic problem throughout the industry or just a temporary setback?
Headwinds for Retail
There are many reasons to question the future of brick-and-mortar retail businesses. All you have to do is stroll down to your local mall on a weekend. What used to be the “place to hang out” with parking lots so full you had to park a half-mile away, is now a virtual ghost town.
I often question how some stores remain in business. Sears is a perfect example, which has been on a multi-year death spiral, unable to compete with the likes of Wal-Mart, Target, Amazon, Home Depot, and Lowe’s. Mall-based department stores just do not appear to be good investments at this time.
The retail industry has been one of the worst-performing sectors this year. Lower than expected holiday sales and a high number of store closures have negatively impacted the industry in recent weeks. Additionally, changing consumer shopping habits, heavy discounting, and now, the threat of border tax adjustments all continue to weigh on the sector.
Even Target, famously known today as the place moms like to go by themselves to “grab a Starbucks and walk every single aisle,” took a beating this week with its biggest single-day drop since December 2008. Target’s 4th quarter earnings were below expectations and its year-long outlook was below analyst projections:
“Our fourth-quarter results reflect the impact of rapidly-changing consumer behavior, which drove very strong digital growth but unexpected softness in our stores,” said Chief Executive Brian Cornell. “While the transition to this new model will present headwinds to our sales and profit performance in the short term, we are confident that these changes will best-position Target for continued success over the long term.”
Glimmers of Hope
Yet, better-than-expected results from retailers like Wal-Mart, Macy’s, Lowe’s, Home Depot, and Nordstrom pushed the stocks higher, instilling a little confidence back into the industry. As an example of corporate adaptation to a new consumer environment, last month Wal-Mart announced a new initiative to offer free 2-day shipping for millions of online items in an effort to compete with Amazon Prime.
Some companies like Costco, which reported weaker-than-expected earnings and profit margins this past quarter, and announced plans to increase membership fees for the first time in five years, still remain focused on the in-store experience.
Costco uses its online presence to emphasize its member experience, enable faster delivery, and provide status of in-store stock levels, rather than try to transition to an online-centric business. It continues to focus on getting people into its stores upon the believe that consumers will spend more money in the warehouses than they would online.
Other retailers emphasize access to premium brands that cannot be purchased elsewhere. These are the luxury brands that appeal to a person’s ego: Giorgio Armani, Ralph Lauren, Prada, Dior, Louis Vuitton. These retailers focus on the customer experience, ensuring consumers know when they step through their doors they are entering a world that’s rare and special.
Take, for instance, Louis Vuitton. Who in their right mind would spend thousands of dollars on a handbag??? But yet, that is who they cater towards and are quite successful.
Abercrombie & Fitch gives its street-level stores a home-like feel through attention to architectural detail. It sends the message to customers that they are valued by demonstrating the company is willing to spend the money to create an environment of comfort.
For premium brands, the exclusivity of the label and the intimacy of the shopping experience are their counters to the online retail movement. While this effort appears to be working for now, high-end retailers will need to evolve their identity over time, ensuring their shopping experience continues to set them apart from the crowd.
Traditional brick-and-mortar retailers need to innovate to take on internet giants such as Amazon, and not just try the same things over-and-over again while expecting different results. Simply setting up a website and advertising a store’s online presence without operating with the expertise of e-commerce specialists is a recipe for failure.
Amazon has set the standard for the online experience — if brick-and-mortar retailers are to succeed in the digital marketplace, they must meet and exceed the consumer online end-to-end experience by improving their infrastructure, systems, and technology.
Or, perhaps these online retailers will find ways to bring the benefits of brick-and-mortar retailers to consumers. For instance, how many times have you gone to a store, tested out or tried on an item, only to then search for it online and buy it at a cheaper price? What if Amazon provided a way to “try out” an article of clothing, new tool, etc. with an effortless return or exchange service?
Retail ETF Analysis
While taking all of this into consideration, we have been watching the SPDR S&P Retail ETF (XRT) since late December 2016 as it fell off its 52-week high. On one hand, it seems like it could be our next great value buy as it continues downhill towards our Buy Threshold. On the other hand, it’s the only ETF on our list that is dropping in price at a rapid rate as the rest of the stock market is hitting new highs on almost a daily basis.
When we looked at XRT’s holdings, the first thing that hit us was that no single stock composed more than 1.5% of the portfolio, which is a significant difference compared to most of the other SPDRs (4-5% on average for their top holdings). That even distribution helps to weather the effect of any single stock taking down the whole ETF, but it also prevents a few strong performers from countering the below-average performance of several stocks.
As of March 3, 2017, here are XRT’s top 25 holdings:
The next thing I realized is that there is quite a mix of businesses — online retailers such as Netflix, Priceline, Amazon.com, and Groupon; brick-and-mortar stores Ulta, Burlington Stores, Costco, and Wal-Mart; premium retailers such as Tiffany & Co; and even automotive retailers like CarMax, Monro, and O’Reilly.
In total, XRT holds 102 securities: apparel retail makes up 22.6%, while internet & direct marketing retail, specialty stores, and automotive retail also have a double-digit allocation each. If nothing else, XRT is pretty well diversified throughout the retail industry.
At this point, we will continue to monitor the sector for it to stabilize. Some retailers may go the way of Blockbuster if they cannot adapt to the marketplace, while others will innovate, adapt, and survive. Regardless, many retail companies offer consumer goods that we can’t live without — such as clothing and food — and because of that will eventually help end the industry’s slide and begin its recovery.
We’ll continue to evaluate the industry, looking for an opportune buying situation that meets our strategy, should one present itself.
What are your thoughts on the retail industry? Is this a good buy now or in the near future? What stores will survive, and which will go bankrupt? Please share your thoughts below!