Ivy Sector Insights – Consumer discretionary
Commentary as of April 3, 2020
What three things should long-term investors consider when it comes to apparel and luxury goods?
The first is who will survive? While we expect many companies will survive, our focus is on identifying companies we believe are best positioned to survive this current environment without diluting equity shares or raising additional capital. Balance sheets and liquidity are of upmost importance when looking at companies at this time. Other considerations include whether companies currently are able to generate revenue via e-commerce channels while most brick and mortar locations are shut down. Regional exposure generally is also helpful.
Companies with seasonal skews outside of the current timeframe may fare this environment well. For example, a winter clothing company's sales may not be as heavily impacted in this current market since its peak sales have already occurred.
Secondly, investors should take a longer-term view when analyzing an investment opportunity and consider how a company's business model will look when this pandemic subsides. As part of that analysis, we want to determine how long will it take demand and profitability to reach normal levels, as well as how long will it take for demand to reach peak levels of the past.
Lastly, investors need to consider whether the potential returns from an investment opportunity are? worth the risks of uncertainty inherent in this environment. It’s important to keep in mind most companies haven’t reported earnings yet so we have yet to see the worst of the downturn in company fundamentals. Assessing how this selloff has been relative to past bear markets and where valuations are relative to past bear market troughs can be very helpful in providing context as an investor.
With stimulus checks soon being distributed, which areas of retail do you think will benefit the most?
We believe most of those checks will go toward consumer staples goods. In terms of consumer discretionary, one area we believe could benefit is athletic brands since exercising is one of the few activities people are still able to do. On a relative basis, these types of companies are likely to be better positioned to capture consumer spending in the near term.
For example, Nike has an entire ecosystem of apps, offering everything from in-home workout instruction to tracking consumer workout progress. The company reportedly saw an increase in its app adoption in China during the country’s lockdown period. Under Armour and Adidas also have fitness apps and could benefit in this environment. We also wouldn’t be surprised to see a shift from dress clothing spending to more comfortable clothing like athletic wear with so many consumers working from home.
Within your coverage universe, how do you distinguish the difference between a company's temporary impact to earnings power versus a more permanent impact to earnings power?
We believe even the stronger brands are likely to see an element of deferred sales and lost sales. There are products sitting on shelves that will get sold eventually, but most likely at drastically reduced prices. In addition, seasonal categories have a more finite shelf life and a portion of these inventories likely will go unsold. As we consider what demand trends will look like whenever we get back to a more normal level, we believe athletic brands are currently well positioned, with demand as good or better on the other side of this. On the opposite side of the spectrum, we believe luxury goods may suffer somewhat once the market recovers. During the last major economic downturn, the consumer became more value conscious, which is a trend that could repeat itself.
Why would apparel or athletic manufacturers have a brick and mortar presence when they could simply sell direct online or via an anchor store in a mall and not take on the risk?
Brands view brick and mortar as a necessary evil because they offer broad distribution, reach, and more control over product lines than in the wholesale channel. Certainly the stronger brands that are traffic drivers – Nike or Under Armour – are directing clients to their own direct channels. Selling everything through e-commerce isn't realistic because of the convenience aspect of going to a physical store and the brand awareness they can provide. There is a necessity to have physical stores even as the world continues to shift toward e-commerce.
We look for companies that analyze their consumer demographics and market segmentation and use that data to best serve their consumer base. The best business models adapt to consumer needs because there's not just a "one size fits all" model. Many high-end brands use their e-commerce business for new releases, while more price-conscious consumers may find more value in factory stores. We don't think that will cannibalize sales from the high-end shopper who wants the latest and greatest product. In high-end luxury, you wouldn't want to wholesale because that would take away from the branding. We think the bottom line is that it really depends on the business model and the market segmentation.
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Risk factors: Investment return and principal will fluctuate, and it is possible to lose money by investing. Securities of companies within specific industries or sectors of the economy may periodically perform differently than the overall market.
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