Retail is giving Wall Street fits
What does it say about the industry that investors are betting against retailers lately? Maybe a little. But not much.
Wall Street's recent beef with retail is artfully captured by lyrics in Hank Williams Jr.'s song "Country Boys Can Survive": "The interest is up and the stock market's down, and you only get mugged if you go downtown."
Actually, all kinds of retailers are boosting sales by going downtown. Indeed, retail overall has had quite a good year thanks to rising employment and wages, and buoyant consumer confidence. Holiday sales have been robust, including Black Friday. Yet investors have grown touchy about the sector, sending several companies' stocks down as their third quarter reports came in. As of Thursday, the Standard & Poor's 500 was down 15.5% for the year, while the S&P retail index was down 21.6%.
It's not that all is rosy, of course. In recent weeks and months, tariffs, hurricanes, interest rate hikes and gas and freight price spikes have threatened to undermine several retail businesses and sectors. There are also signs that the economy's great run, and the confidence of consumers, may be ebbing. That all may be spooking investors.
"With just 2 weeks left in the year, investors clearly appear to be 'climbing a wall of worry' in regards to retail," Wells Fargo Senior Analyst Ike Boruchow wrote in comments emailed to Retail Dive last week. "[W]e think that investors today are less concerned about current trends and more focused on the uncertainty around 2019."
There's a disconnect, then, between Wall Street and High Street at the moment. "While retail is doing well, retail stocks are faring badly," GlobalData Retail Managing Director Neil Saunders told Retail Dive in an email. "The rising tide of growth has masked some underlying issues. As the tide ebbs these problems will come to the fore again. Investors are increasingly recognizing this as they look ahead."
Retail is doing well on the top line, but there "are still many pressures on the bottom line," he said. "Wages are rising, freight costs are higher, there is the potential impact of tariffs, and the growth of ecommerce with low-cost of free shipping is damaging margins. All of these things have the potential to erode earnings and this is making Wall Street nervous about the retail outlook."
Knowns and unknowns both cause pain
Gale forces have shaken retail in the last decade or more, including Amazon's ongoing disruptions, a Great Recession and an over-built landscape. Several legacy retailers have, at long last, responded by making major structural and technological changes that have boosted their e-commerce, improved their marketing, rationalized their footprints and marked their recovery. While in many ways retail must still adhere to fundamentals that seem as old as time, those changes are significant and their consequences can be difficult to evaluate. And a host of newer direct-to-consumer startups have joined Amazon in continuing to disrupt the industry.
"The mechanisms and metrics of success in retail have changed over the past few years. The shift to digital is monumental," Greg Portell, lead partner in the global consumer and retail practice of strategy and management consulting firm A.T. Kearney, told Retail Dive in an interview. "Face it — we're breaking new ground. There's a lot of blurriness in how retailers manage those channel conflicts. And that feeds into skepticism that investors have [of retail management]. They have algorithms for their math, but they don't have an algorithm for digital growth or digital profitability. They're now relying on management to put that new Ferrari to the test and adjust on the fly."
The extent and expense of the investments and adjustments, and the possible need for yet more, could be making investors nervous, according to Saunders. "There are still many structural issues which retailers need to address," he said. "Things like store closures, investment in e-commerce and logistics, and the refinement of product offers are all looming. As much as these things are necessary they all have the potential to cause short term pain to the sector."
Furthermore, investor qualms may be based on mixed up expectations in a rapidly evolving industry. "Established retailers like Macy's, Walmart, Target — all who have profit levels and investors who are expecting profitable growth — are competing against venture capital investors who are not expecting profitability but are expecting growth," noted Portell. "To then judge the success of either one on profitability is a bit unfair."
Another source of angst for investors at the end of the year is what for retail has been an age-old reality: that not everyone will exit the holidays unscathed. "Even with strong consumer sentiment there will be winners and losers this holiday season," Portell said. "We are not at a point where rising tides raise all boats — some retailers are going to be decimated and we don't really know which ones."
Retail can survive
Rising tides aren't the only issue. When it comes to stock sell-offs, "A receding tide strands all boats, which is what you have now," Instinet Senior Analyst Simeon Siegel told Retail Dive in an interview. If a downturn in a retailer's stock is deemed unwarranted, that will entice investors back, but it's a treasure hunt. "It'll be up to investors to determine which of the newly cheapened stocks are companies that they believe will have a stronger 2019, that the fears are overdone," he said.
Uncertainty could carry well into the new year, according to Wells Fargo's note. "[W]e think bears will continue to dominate the conversation for the time being," Boruchow's team wrote.
Some investors believe that, as well as retail has done of late, "this is as good as it may get," Saunders said. "There is a lot of downside in this quarter and into 2019. Prior year comparatives become tougher and the benefits of tax cuts start to fade. This downside is reflected in a more cautious view from investors."
Things will get more clear next year, Siegel believes. "When the dust settles and investors are allowed to actually look at the landscape of companies I think we're going to find there are some very interesting assets, there are strong companies that are finally trading at levels where people can make calls and can make bets."
It would be a mistake to read too much into investors' stock market wagers, however, experts say. Better to look at a swath of indicators. "Like inventory, which was not as healthy as everyone believed," said Siegel, who raised eyebrows in a note last month warning that "inventory isn't as clean as it seems," based on a year of observations. "I think [inventory] was just hiding out in the off-price channel and now we're finally seeing [it] hit the department store channel," he told Retail Dive.
What's really important
With retail facing elemental changes, plus the usual shifts in consumer behavior and the vagaries of the macro environment, Wall Street is often criticized for putting short-term pressure onto companies that need time to respond. But retailers aren't being held to an unfair standard, Siegel says.
"All public companies have quarterly calls, and retail, more than other businesses, is actually more seasonal," he said. "You can imagine other sectors that actually do not see this level of volatility because the investments they make don't bear fruit and therefore are not expected to bear fruit for a much longer duration. The problem with retail is that every bet is judged every season or every day — the bets that management place are validated or proven wrong on a recurring basis. The reality is the quarters do matter and that's why people actually do care. Inflections are more normalized than consistency."
In fact, most retailers used to report monthly comps and now very few do, yet stock volatility seems to have increased, he noted. That's in part because investors dumping retail stocks aren't necessarily employing reasons that can be extrapolated into a meaningful assessment of the industry or even a given retailer. But stock moves could represent a tap on the shoulder that asks what more could be done.
"I think that we're creating the narrative and the rhetoric around the health of retail or lack thereof based on whether stock screens are green or red," Siegel said. "When what's really important is that the mall never died, but it also was never amazing. As you create those narratives and as stock movements help dictate those narratives, it is important to take a step back and say, 'How is the business doing?'"
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