In February 2019, the Bowen Asset Management team attended the 26th Annual Groundhog Day Investment Forum in Philadelphia presented by the Lancaster County-based Emerald Advisers, Inc. As with Emerald’s annual Las Vegas conference, the day-long event offered intriguing and informative panel discussions, featuring Emerald’s talented and insightful analysts and managers, as well as top investment and retail experts and representatives from an eclectic array of companies, including: retailers Five Below, medical device manufacturer Integer, Florida community bankers Amerant, deck builders Trex, and casino slot machine makers PlayAGS. Among the notable speakers were Emerald founder and CEO Joseph Besecker, retail analyst Dana Telsey, author and trend identifier Cathie Wood, and economist Joel Naroff.
Here are some highlights of the forum:
Telsey, one of Wall Street’s leading analysts, noted that retail sales over the holidays had turned out well, with a lift in the last week before Christmas helped by an extra day as Christmas came on a Tuesday in 2018. According to MasterCard SpendingPulse, total retail sales, excluding automobiles, rose 5.1% between Nov. 1 and Dec. 24 from a year earlier. A big boost came in apparel, which increased 7.9%. However, Telsey observed, the season had been “a real nail-biter” to the end.
Telsey noted the main action was not at department stores, where holiday sales saw an anemic 1.3% drop. One key to improvement is using data to appeal to consumers in a personalized way to get repeat business, she said, as well as taking an “experiential approach” to marketing, like how athletic apparel maker Lululemon positions the consumer as “the star” of what they’re buying.
Along these lines, Telsey stressed innovation in the retail industry, especially the “click-and-collect” concept which allows consumers to purchase goods online and then make a pick-up in the brick-and-mortar store, integrating the physical premises with the digital service. She noted that this has had an impressive “attachment rate” effect on sales, with around 25% of click-and collect transactions resulting in an extra purchase being made on premises. But the experience will be different-while physical stores are expected to retain their value, up to 20% of space that is now devoted to parking could disappear, with drive-thru as replacement.
Still, the 2019 outlook is clouded with uncertainty, she noted, with store-closing announcements for big-box stores and the fading of famous names such as Sears “not a matter of if but when.” As a result of the loss of anchors, malls and shopping centers are looking for new categories, from spas and wellness centers to restaurants and high-end food markets, which in turn will drive business to smaller nearby stores. In the future, Telsey says, there may not be as many department stores, but those that remain will be more relevant, focused on “lifestyle and experiential” goods.
One example of an innovative seller mentioned by Telsey was the Philadelphia-based discounter Five Below, which was represented by the company’s vice president for investor relations, Christiane Pelz. Pelz noted that Five Below’s growth of 20% came from a particular focus on an underserved clientele, tweens and teens, a focus on trends, locations in high-traffic areas, and a low-cost operating philosophy (for example, rather than ship basketballs inflated in boxes, they are deflated and shipped flat to be pumped up in-store).
Bowen Asset Management believes retail sales data for December 2018 released by the U.S. Census Bureau also showed holiday sales were not quite as good as expected. Sales totaled a seasonally adjusted $505.8 billion, falling 1.2% from November 2018. It was also a poor performance on a year-over-year basis, as December 2018’s sales rose just 2.3% from 2017, while November and October 2018 jumped 4.1% and 3.7% from 2017, respectively.
Bowen Asset Management also believes that e-commerce wasn’t able to buck the industry trend, turning in a poor performance as well. Both the numbers for e-commerce and the industry trend were low enough that some GDP forecasts were adjusted substantially lower, though not to recession levels. The non-store sales segment, which includes e-commerce, saw its month-to-month growth hit minus-3.9%, significantly worse than the industry overall. And the segment’s year-over-year growth came in at 3.7% in December, which is better than the rest of retail, but marks a significant deceleration, as the segment grew 11.1% in November 2018 and 8.4% in October 2018 from 2017. So, even though e-commerce is growing faster than retail generally — it was up 9.6% for all of 2018—it was part of retail’s overall problem in December.
Low December sales hurt retailers that rely heavily on the holiday season. Some retailers count on the last two months of the year to bring in a large share of their annual sales, and December coming up short can be problematic. Less revenue from the holidays will likely lead to store closings, bankruptcies, and other issues for physical retailers, while e-tailers may find themselves in financial struggles. We agree with Telsey that the key for physical stores going forward is her mantra of “renovate, reinvent, and redevelop” in order to stay in business.
Cathie Wood, CEO of ARK Investment, spoke about the global economy undergoing significant technological transformation. She identifies five primary “innovation platforms” creating what may be the most transformative period in human history. These five areas are blockchain technology, genome sequencing, artificial intelligence, robotics, and energy storage.
Wood feels that blockchain is at a tipping point and equates this to the position of the internet in the 1990s. Genome sequencing costs are declining and may soon become an ordinary part of physical exams. Robotics may lead to displacement of workers, but will present new job-creation opportunities. Artificial intelligence, on the other hand, is likely to see a phasing out of human programmers, with machines training and developing each other, and a rise in quantum computing.
On energy storage, sharp lithium-battery cost declines could mean that electric vehicles will be cheaper than gas-powered transportation, with electric cars costing as much as a gas-guzzler by 2025. Electric vehicle sales could top 26 million by then, with China being the largest market due to government subsidies. A rise in self-driving vehicles could further cut the costs of transportation, but lead to more congestion. This could mean a drop in gas-powered car sales, a decrease in demand for oil, and falling insurance costs. In addition Wood is looking for an increase in automobile utilization. Currently, cars sit parked 95% of the time. Alternative shared ownership trends will drive utilization substantially higher as the percentage of parked time drops.
As it all relates to Bowen’s investment strategies, our main issue is how to position investment as these systemic changes rapidly occur. For example, we are most likely never going to be spending less on cybersecurity going forward than we are now. Fundamental research, such as that presented at the Emerald forum, can help with determining what areas to invest in.
Economist Joel Naroff said that he thought the trend in the economy for 2019 would be a leveling off from 2018 to where it should have been without the “sugar high” from the recent tax changes. There is still hope that businesses may actually invest more this year. However, with over one trillion dollars in corporate buybacks vacuuming up much of the tax breaks, Naroff is not counting on that happening. He also is expecting two rate hikes by the Federal Reserve in 2019, especially if the China trade “problem” is cleared up, with the first hike coming in June at the earliest. A cloud in the distance: although nobody is expecting a recession in 2019, Naroff has put one in his forecast for mid-2020.
The general takeaway from the forum for Bowen Asset Management is that political noise may affect the market short-term, but absent some black-swan event, it should not affect the slow growth trends of the market over the long-term. Never bet against the U.S. economy long-term.
For example, a footwear manufacturer may have had a small portion of its business in China, but because of the tariff negotiations, may move a larger portion of its business to Cambodia or Vietnam to circumvent the U.S. tariffs on Chinese goods. These companies are still not coming back to the U.S. to build factories but just moving on to countries with cheap labor to keep costs low and deliver cheap goods to the U.S. which American consumers have become accustomed to. This will cause increased costs short-term as the firms move and could thus possibly suppress earnings while it is happening, but should be good for the companies over the longer term. American consumers will pay more short-term for some goods made in China to cover the tariffs but the impact should be minimal in duration.
The bottom line: over the long-term, proper fundamental research will pay off with investment in good companies with value and or growth.
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