Behind the Numbers had some interesting comments on the retail sector in this week’s Thursday Thoughts:
Tuesday’s front page article in the WSJ did a nice job explaining how rising costs and shifting spending habits are stifling the consumer’s discretionary shopping. While such a premise may seem suspect in an environment of low inflation and ultra-low interest rates, consumers are funneling much more money to a few specific, often fixed cost items, than they were just a few years ago. These higher fixed expenses appear to be limiting Americans’ ability to purchase discretionary goods. [Emphasis mine]
Although the employment situation has improved markedly from the financial crisis, progress has been slow and wage growth has been particularly disappointing. Meanwhile, the WSJ found that health care spending by middle income Americans grew by 24% between 2007 and 2013. Another area sapping consumer finances is internet service. The middle 60% of consumers (by income) has ramped the amount they spend to access the web by 80% over the last half-decade. Spending on cable and satellite TV is up 24% for this group. While smart phones may have made life more convenient for Americans, the middle 60% has seen their cell phone spending jump by 50%.
Charles here. I expect the increased on cable and satellite spending to go into reverse soon. Consumers are increasingly pushing back against rising cable bills, and HBO just fired a major warning shot to the industry with its announcement that it would be selling directly to consumers via its streaming service starting next year. That entire business model is on the verge of unravelling, but that is a longer conversation for another day.
Getting back to discretionary spending, lower electric utility and gas bills from falling energy prices also free up a modest amount of cash, though we’re talking about $100-$200 per family per month at most. Meanwhile, the overall picture looks terrible. As Behind the Numbers continues,
The figures are based on surveys of 14,000 households who kept spending diaries. The study was designed to examine the spending habits of the middle 60% of the population based on income. Total spending by the group rose by 2.3% over the period while incomes rose less than 0.5%. Inflation rose 12% point to point. From these figures alone one would surmise consumers are increasingly forced into setting priorities and losing the ability to make discretionary purchases.
As an example of this lack of discretion, the higher fixed costs resulted in the households examined spending 26.5% less on “household textiles” which includes bed and bath linens. Even spending on care for the children and elderly fell 25% as Americans figured out a way to work from home or make other arrangements.
This sort of behavior sounds like a major headwind for retailers, not only those selling discretionary goods, but also those, like Walmart (WMT), that cater to the financially strapped. Walmart’s struggles are well known as it reported negative same store sales in its last fiscal year and recently posted its first positive comparison in seven quarters.
Are online sales the answer? Doubtful. Amazon (NASDAQ:AMZN), though a fast revenue grower, has never really generated much in the way of profits. And online sales are arguably a profit killer for traditional retailers. As Behind the Numbers continues,
While the struggles to maintain traffic no doubt reflect increasing online sales, simply moving sales from a physical store to a warehouse is no guarantee of margin improvement. Some experts even argue that shipping, handling and returns can actually make web business less profitable than brick and mortar retailing. Kohl’s, for example, says its online business is half as profitable as its store business. Further, as fewer customers visit a company’s stores, per unit fixed costs rise on that portion of sales. This looks like an industry where it will be increasingly tough to pick long term winners.
I’ve been investing fairly heavily in the retail sector, particularly in serial dividend growers like Wal-Mart Stores Inc (NYSE:WMT), Target (NYSE:TGT) and Home Depot (NYSE:HD). As a group, the sector was cheap and, until recently, out of favor with investors, making it a solid contrarian value play. The bargains are getting harder to find, however, and I agree with Behind the Numbers when they say that picking winners will be tough.
In a tough overall retail environment–and one in which U.S. stocks are broadly overvalued by all traditional metrics–my advice is to forget trying to pick the next trendy retail stock. Instead, stick with shareholder friendly serial dividend raisers and share repurchasers. Slow and steady wins the race.