Ivy Sector Insights – Consumer Discretionary & Consumer Staples
Commentary as of April 2, 2020
The COVID-19 pandemic has impacted retail in many unique ways. There are several online, low-touch merchants that are benefitting from the current environment, though non-essential, brick-in-mortar counterparts are facing large headwinds as imposed lockdowns are adversely impacting consumption in the traditional sense. It’s safe to say, the current market environment is unprecedented.
How are you grappling with the current retail environment?
This is a truly unprecedented situation. On one end, we’re seeing long lines form at places like Costco and Walmart. On the other end, department stores are literally shutting down, and furloughing employees. No one was prepared for a zero-revenue scenario, which is now the reality that many are facing. While there are many losers to talk about, as a long-only investor, I’ll try to focus on the perceived winners and frame it as near-term beneficiaries and long-term beneficiaries.
I think there are two direct beneficiaries in the near-term, the essential brick’n mortar retailers like Walmart, Costco, Kroger and E-commerce players like Amazon.
While the increased online shopping is obvious due to the lockdowns, I think it’s worth digging a bit deeper on the tailwind the essential retailers are seeing. While there is clearly some panic buying (or stockpiling) going on right now that will likely be short-lived, there is also a legitimate increase in demand for grocery spending as well, for several reasons: 1) schools are closed so parents need to feed their children at home, 2) restaurants are closed or have limited options, and 3) more individuals are staying home due to fears of contracting the virus. While the first two factors will likely go away once the lockdowns are lifted, the fear factor will likely linger a bit longer, so I would expect to see elevated grocery demand for at least for a few more quarters.
However, we’re not necessarily recommending adding more to these essential retail stocks right now as we believe the tailwind is transitory. Also, stocks like Walmart, Costco and Kroger have all held up very well in the current market sell-off, as this is exactly the time when these kinds of defensive stocks typically perform well. If we see a market recovery, I think alpha will be found elsewhere.
To frame the long-term beneficiaries, I think it is important to focus on the behavioral changes that will likely persist among consumers, and think through the structural changes the retail landscape will go through.
In terms of behavioral change, these are exactly the times that consumers are more willing to change their behaviors, and I believe some of those behaviors will stick with them even after the pandemic is behind us. From that perspective, I believe online grocery is worth paying attention to, as we are seeing huge surge in demand for Amazon Fresh, Walmart grocery pickup, Instacart, etc. There is always friction in trying out a new type of service. In this case, you have to download the app, set up an account, select the items that you want to order, and get it delivered or drive by for a pick-up. Assuming the customer is happy with her/his experience, there is much less friction in re-ordering their regular pantry items with a few clicks, and I believe many will continue to do so going forward. As a result, I believe we’ll see a step-change in online grocery penetration this year, and further see adoption accelerate in the coming years.
While traditional grocers will also participate in this arena, I believe the biggest winners will be the larger players that also carry non-grocery goods, such as Amazon and Walmart. Grocery is a high frequency, but low margin category. So it’s not that attractive from a profitability stand point, but very attractive from a frequency and customer engagement stand point. By upselling higher margin goods along with the grocery basket, I believe Amazon and Walmart are best positioned to capitalize on the online grocery opportunity compared to traditional grocers.
In terms of structural changes in retail, the U.S. was already chronically over-stored with too many malls and too many specialty stores. As more people shop online, department stores and mall-based specialty retailers were already struggling heading into this crisis, and now they are literally in survival mode. This pandemic may very well be the nail in the coffin for many of them. I would expect more bankruptcies and store closures in the coming months. For instance, retailers like Neiman Marcus, Lord & Taylor are either in talks to file for bankruptcy or considering to liquidate their business. As we see such supply rationalization, I believe off-price retailers like TJ Maxx, Ross, and Burlington are poised to gain share by capitalizing on the unsold inventories and selling them at a discount.
It sounds like the strong are getting stronger, and the weak are getting weaker. Do you see opportunities from an investment standpoint, or is most of this already reflected in market prices?
I don't see a huge dislocation in the more defensive names like Costco and Walmart, but I do believe there are some dislocations among the off-price retailers relative to the opportunity that lies ahead. They also had to shut down their stores recently, which resulted in a panic sell-off of their stocks, but I believe they are well positioned to capitalize on the glut of apparel inventory, and gain more market share, which will likely be reflected in their valuation in the coming quarters.
Some of the larger retailers like Amazon have announced hiring a large number of associates. Do you think this level of hiring will help offset the growing number of job cuts?
It likely won’t be enough to offset the job losses we are about to see. I believe the passage of the CARES Act helps. Small businesses will take advantage of the forgivable loans which are meant to be used as a bridge. I don’t think it will solve everything, but it will help soften the blow. Assuming majority of these small businesses do survive, many folks will likely go back to their prior jobs. However, inevitably, there will be some business failures, and portion of the job losses will be permanent. Also, keep in mind that while retailers such as Amazon (100,000) and Walmart (150,000) are hiring many workers, most of those are temporary positions so it won’t be able to replace the full-time jobs that will be lost.
Past performance is no guarantee of future results. This information is not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through April 2, 2020, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This information is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.
The CARES Act is the Coronavirus Aid, Relief, and Economic Security Act, a law meant to address the economic fallout of the 2020 coronavirus pandemic in the United States.
The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.
Alpha is a measure of a security's actual returns and expected performance, given its level of risk.
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.