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Key Points:

  • America has significantly more retail space than any other industrialized nation.
  • Retail bankruptcies have gone vertical in 2020. The retail landscape is changing rapidly.
  • The survivors and innovators will take significant market share and emerge as powerhouses.

America is over-retailed with well over 1,100 malls across the country and thousands more strip-shopping centers. Many of these malls and centers are in physical decline and are filled with irrelevant brands that sell products and services that are no longer important. The retail cleansing had already begun before the Covid-19 pandemic, but the process has been accelerated dramatically.

A classic case of retail Darwinism is now in progress. Because of forced lockdowns, tens of millions of Americans were funneled through a very narrow door connected to the biggest and most iconic retailers. Great for the big guys, terrible for the mom and pop retailers. As investors in the consumer spending theme, we must understand the new retail environment and consider how consumers are now spending as we pick stocks for clients. The bottom line: the most relevant brands came into the pandemic strong and have emerged even stronger. That’s a bankable investment thesis. I find it ironic though that most investors are woefully underweight these tremendous retail stocks at a time when their futures have never been brighter. Remember, retail sales are roughly 30% of total U.S. GDP or about $5 trillion a year which makes exposure to the theme vital if you want to track the real economy.

As the retail landscape changes, millions of retail tenants are paying little to no rent and fighting for survival. The more relevant brands that are primarily national in scope have better access to capital and at rates that are favorable. The smart retailers are using the current access to capital and the difficulty the local peers are having as a competitive weapon. Expand when others contract is their motto. There will continue to be a significant amount of retail space turnover in the coming few years and the most relevant brands will soak up a lot of that space at attractive new lease rates which should drive continued revenue growth. But make no mistake, their growth, and the new opportunities they have will be at the expense of smaller, more local retailers that have been struggling for years.

Retail2.0 starts with rising bankruptcies.

The image below from Hedgeye Research highlights the bankruptcy landscape across retail. It’s ugly and it will continue but out of the ashes will usher in a whole new group of well-funded and innovative brands geared toward delighting consumers. Some of them will ultimately fail and others will take market share from the biggest retailers like Target, Walmart, etc. Honestly, I’d rather just get through this process because there are so many brands that add no value to consumers and have simply survived because of a good economy. As Warren Buffet likes to say, “when the tide goes out, we get to see who’s naked.” Currently, there’s a lot of naked retailers lathered up with debt they can’t service and consumers who haven’t returned to the stores. Here’s a small list of some of the high-profile bankruptcies or reorganizations this year: Neiman Marcus, J.C. Penney, Lucky Brand, GNC, Brooks Brothers, Lord & Taylor, Men’s Warehouse & Jos. A Bank (Tailored Brands), Ann Taylor, Tuesday Morning, Sur La Table. Starbucks announced it would close 400+ stores but will open a similar number of new stores that are better equipped and with drive-through capabilities. Bed Bath & Beyond closed over 200 stores thus far and Macy’s has significantly downsized its store count given the tough environment at malls.

The innovators will continue to thrive and take market share.

As an investor, we always look for opportunities even in the face of chaos. For every company that’s struggling, there’s others that are benefitting. Historically, the strong get stronger in economic slowdowns and in retail this concept is incredibly true. Amazon has thrived being a key go-to brand for consumers in need of staples and discretionary items.

Covid-19 put local stores with no online capabilities on their heels, which allowed brands like Amazon, Etsy, and others to lean into the fear and take market share. Millions of consumers were brought into these echo-systems quickly and now that they’ve seen the ease by which purchases and deliveries can happen, I suspect they won’t go back to the old way of doing things. It’s sad to say but Covid-19 will turn out to be the greatest marketing opportunity for the biggest and most relevant brands. Below I have highlighted the retail brands that have clearly benefitted from the pandemic by showing the top ranked brands using a screen that includes: high absolute sales, high sales growth over the trailing one year, higher sales over the trailing 1 year versus the three year average sales growth achieved, high free cash flow generation, and earnings and revenue surprises during their last quarterly earnings. It’s my job to decide if these improving fundamentals are the beginning of a new trend and are sustainable or were more 1-time in nature and likely to mean revert back to the former growth trajectories. Nevertheless, these businesses seem to be thriving in a tough overall environment.

Thriving brands:

UPS & Fed-ex
Dollar General
Home Depot

In today’s retail world, those with the brand recognition and relevance, with a strong balance sheet, that have access to cheap capital, that sell products and services in high demand, that offer a delivery or pick-up strategy that makes consumers feel safe, and have room for additional expansion should continue to thrive. If you’re a restaurant or fast casual brand without a drive-through, your likely re-thinking that strategy now. If your long-term business plan calls for different store formats and sizes, you’re now getting the opportunity to execute that strategy at cheaper retail rents and likely have access to some marquee real estate locations. Even better, you might even be the next group of ideal retain anchor tenants from which an entire shopping center is centered around.

It’s these brands that are best positioned for the retail2.0 environment we see going forward.

Dollar General
Shake Shack
Darden Restaurants (Olive Garden, Longhorn Steakhouse, The Yard House, Capital Grille, Chedders)
Yum Brands (KFC, Taco Bell, Habit Burger)

The Bottom Line:

America has too many retailers. The biggest, most relevant brands continue to expand their footprint and cover more of the consumer needs & wants making smaller, less funded brands move towards obsolescence. This process was already happening and has been accelerated through Covid-19. Small businesses have an uphill battle ahead if they do not provide a product or service that’s differentiated, in high demand and most important, not provided by the biggest retail brands in every community. With the virus lingering for longer, consumers will continue to opt for shopping at fewer retailers and will get used to consolidating their purchases to a smaller handful of partners. If you’re one of these partners, you’re thriving and happy, if you are not, you’re struggling and worried for your survival. As a stock picker who is dedicated to the consumer spending theme, I feel like our team has a leg-up versus generalists that do not understand how to assess brand relevancy and the current landscape. With consumer confidence rebounding more than expected in September, making it the biggest monthly gain in 17 years, there’s significant opportunities for the best positioned brands as we head into an early holiday shopping season. Buy early and get great prices!

Themes We Like this Holiday Season:

  • E-commerce – a physical store needs to offer an unforgettable experience to keep consumers from shopping online with little to no effort. E-commerce has re-set higher and will continue to be in full growth mode.
  • Consumer electronics and devices – video gaming, 5G phones, iPad, laptops, Alexa devices, Apple watches and other wearable devices seem well positioned for the holidays.
  • Athleisure – the apparel category in general has been a laggard but the athleisure and exercise categories are thriving currently. We see no stoppage in that trend anytime soon. This is a key global theme in portfolios.