We’re a little over six years from the Great Recession, and a look at the average time between recessions since the Great Depression – there have been 13, inclusive of the two already mentioned – suggests we are far closer to the next than we are the last.
China is in turmoil and Germany, Australia and Japan are felling collateral damage. Inflation across developed nations is virtually nonexistent, and central banks are scrambling to regain control ahead of a downturn that – if things remain as is – they will have little to no monetary tools with which to counter.
It won’t take much movement (say a 30-35% decline) in the equities markets to instigate a negative wealth effect, and the implications this has for consumer spending, market sentiment and – eventually – employment. In short, it’s time to start thinking about safe haven allocations.
Gold, of course, is the go to risk off asset, but a number of industries thrive on recession.
One such industry is the thrift space. Here is a group of thrift space exposures that could make for great allocations if, and when, things take a turn for the worse.
Let’s start with the obvious candidates.
Dollar Tree, Inc. (O:DLTR)
Dollar Tree just closed on its long awaited acquisition of discount retail peer Dollar General (N:DG), and, despite a rough second half of 2015, continues to print strong numbers. During the three months to October 31, 2015, the company pulled in $4.95 billion revenues for a gross profit of $1.4 billion and a net $81.9 million. Full year financials, alongside holiday period reports, are due February 24, 2016, and analysts expect a strong final quarter. If the numbers come in as expected, it should kick off a strong year for the company – and that’s while things remain buoyant. If the economy takes a turn for the worse, Dollar Tree’s (and now, Dollar General’s) deeply discounted products should draw increased attention, and the company could gain further. Its market capitalization is down 10% on end of 2015 highs, representing an opportunity for a discounted entry ahead of a recovery.
Big Lots Inc. (N:BIG)
Big Lots offers a wide variety of goods at a discount, everything from food and drink to household furniture – the latter of which has boosted the company’s bottom line over the past twelve months through a financing program. It generated in excess of $1.1 billion revenues in each of the last six quarters and, with the exception of last quarter, during which the company invested in a wide scale revamp of its stores, regularly posts a net income in the triple digit hundreds of millions. Big Lots expects to report an EPS in the range of $1.95-2.00 for the final quarter of 2015 (due March 4, 2016).
The company has $62 million cash on hand as of October 31, 2015, with a further $48 million due in net receivables and $1 billion worth of stock. With a current market cap of just $1.7 billion, down 30% on 2015 highs, it looks cheap. Analysts agree, with a mean target of $50.83 across those that follow the company.
Now for some less obvious candidates.
Tuesday Morning Corporation (O:TUES)
This Dallas-based company sells decorative home goods, bath and kitchenware etc., through a network of close to 800 outlets, across 41 states. It’s business model involves sourcing high volume closeout items – items that free up as other outlets clear out stock – from across the US and Europe. It only buys up named brand, reputable stock, and as such, markets itself as a deep-discount luxury item retailer. Tuesday Morning just reported second quarter fiscal 2016 results, and outperformed on almost every metric. Net sales hit $319.9 million, up from $301.4 million during the same period a year earlier. Net income came in at $18.9 million, or $0.43 per share. It’s just about to open a national distribution center in Phoenix, which positions it to satiate any increased demand that comes on the back of an economic downturn, has no debt, cash on hand of $35.3 million and $232 million in stock. Furthermore, it’s down 74% on 2015 highs.
Epic Stores Corp. (OTCMKTS:EPSC)
Epic Stores is a Phoenix, Arizona based outlet that specializes in second hand goods, retailed out of its network of Epic Thrift brand stores. It’s got a slightly different model to the other two companies on the list, which are both buy to retail outlets. Instead, it sources its merchandise through donation.
The company collects about 750,000 lbs. of product each month – 45% of which it recycles, 50% of which it retails and 5% of which it discards. It has a far smaller store count than Tuesday Morning or 99 Cents Only – 12 currently operating – but generates between $700,000 and $1 million revenues at each location, on a zero per-item cost (excluding, of course, operational expense) – a ten times multiple on the average goodwill annual revenues location, reported as $107,000 by the Small Business Chronicle in 2014.
So how does it outperform other companies in the same space? Well, it sells the same items as outlets such as the Salvation Army, or Goodwill, but it attempts to emulate the shopping experience of higher ticket outlets. Its locations are all major retail zones, its stores are kept clean and bright, and each unit has an average 2000 sq. ft. processing area that allows it to organize stock in a manner consistent with first hand retail.
It’s a small operation – $1.15 million revenues recorded during the three months ended September 30, 2015 – but it’s growing steadily and, assuming a conservative expansion model, should maintain a much better liquidity profile than 99 Cents Only. Further, what other company can boast an 80% gross margin on retail items?
99 Cents Only
This is an indirect exposure, for the investor seeking an element of diversity. In October 2011, Ares Management, L.P. (N:ARES) teamed up with the Canada Pension Plan Investment Board to acquire 99 Cents Only for $1.6 billion.
The company is a deep discount chain, selling a range of items for a fixed, $0.99, price. It’s headquartered in California, and operates most of its network of stores along the East Coast and in Texas. At last count, third quarter fiscal 2015, 99 Cents only generated net sales of $491 million, an increase of 2.8% on the same period a year earlier, and increased its store count by 7.7% between the end of the third quarter 2014 and the same date in 2015.
This isn’t as straight forward an allocation as Tuesday Morning. 99 Cents Only has a weak liquidity profile, high debt, and despite improving net sales between 2014-2015, loses money each quarter. The market capitalization of its parent company, Ares, reflects this fact – the company is down over 45% on 2015 highs and carved out all time lows at the end of January, 2015. It currently sits a little over 5.5% off these lows, at $11.52 a share.
Having said this, if we do get a negative wealth effect, and the subsequent shift in consumer preferences that such an effect would initiate, 99 Cents Only could quickly turn around.
Conclusion
So there we go. The thrift industry is growing faster than the general retail sector in the US, and attracts more than 57 million shoppers annually. Its growth outpaces that of the US economy as a whole, and its constituent stocks make for attractive allocations even under current conditions. Factor in the potential for a near term downturn, and this attraction only strengthens.