corporate taxes, consumer spending and the stock market

It looks as if the top Federal corporate tax rate will be declining from the current world-high 35% to a more median-ish 20% or so.  The consensus guess, which I think is as good as any, is that this change will mean about a 15% one-time increase in profits reported by S&P 500 stocks next year.

However, Wall Street has held the strong belief for a long time that this would happen in a Trump administration.  Arguably (and this is my opinion, too), one big reason for the strength in US publicly traded stocks this year has been that the benefits of corporate tax reform are being steadily, and increasingly, factored into stock quotes.  The action of computers reading news reports about passage is likely, I think, to be the last gasp of tax news bolstering stocks.  And even that bump is likely to be relatively mild.

In fact, one effect of the increased economic stimulus that may come from lower domestic corporate taxes is that the Federal Reserve will feel freer to lean against this strength by moving interest rates up from the current emergency-room lows more quickly than the consensus expects.  Although weening the economy from the addiction to very low-cost borrowing is an unambiguous long-term positive, the increasing attractiveness of fixed income will serve as a brake on nearer-term enthusiasm for stocks.

 

What I do find very bullish for stocks, though, is the surprising strength of consumer spending, both online and in physical stores, this holiday season.  We are now nine years past the worst of the recession, which saw deeply frightening and scarring events–bank failures, massive layoffs, the collapse of world trade.  It seems to me that the consumer spending we are now seeing in the US means that, after almost a decade, people are seeing recession in the rear view mirror for the first time.  I think this has very positive implications for the Consumer discretionary sector–and retail in particular–in 2018.

Cyber Monday

I think the most interesting thing about this year’s Black Friday/Cyber Monday is that, despite the weekend’s decreasing overall relevance for American shoppers, business has been unusually strong.  This is likely in large part because consumers in the aggregate finally–eight years after the bottom of the economy (and 8 1/2 years after the bottom in world stock markets)–feel confident that the recovery is real.  Yes, we still have serious regional, educational and other demographic disparities.  But the typical consumer appears to feel that his/her job is safe and that family finances are enough under control to allow a return to more-or-less normal spending.  This is an important positive economic sign.

If this is correct, then it’s probably also time to begin to sort through the Wall Street wreckage in the retail sector.  I’d be particularly inclined to look at bricks-and-mortar, where more open wallets are likely to make the greatest positive impact.

 

By the way, I’ve been shopping online for a RAID array.  While I was looking on one site, a price comparison app told me that the item I was thinking about was substantially cheaper at Wal-Mart (WMT).  The WMT site told me that I would get $35 off the purchase if I applied for a credit card and bought today–both of which I did.  Almost immediately I got an email that said my purchase had been cancelled, but gave me a phone number to call for an explanation.  I did.  After about 10 minutes of waiting, when I was next in line for an agent, the line disconnected.  I ended up finding the item for the same price and with much faster delivery from B&H.

WMT may be a more formidable competitor for Amazon than it was a year or two ago.  And the AMZN price for what I wanted was 50% higher than WMT’s!!!  But WMT still has a ways to go, at least handling high-volume online days.  That’s probably more a positive than a negative for the stock, however, since there’s still considerable scope for improvement.

 

 

 

more on Whole Foods (WFM) and Amazon (AMZN)

I was reading an article from Fortune magazine about the AMZN takeover of WFM.  Although it echoed much of what the rest of the press is saying, I was struck by it–mostly because my expectations for Fortune are higher than for financial reporting in general.

Three ideas in the article stuck out in particular:

–that AMZN’s goal with WFM is to compete head-to-head in groceries with Wal-Mart (WMT)

—the implication that because the margins of grocery chains are low they have a poor business model

–that the price cuts made by AMZN on Monday are small, therefore they make no difference.

my take

–ten campers, including yourself, are being chased by a bear.  If the goal is purely personal survival, you don’t need to outrun the bear.  You only need to outrun one of the other nine.

Put a different way, the goal of, say, Zara or Suit Supply is not to compete head-to-head on price with WMT.  that would be suicide.  Instead, those firms intend to provide differentiated clothing to a more focused audience.  Yes, it’s still clothing, but it’s different clothing.  Initially, at least, that’s AMZN’s goal with WFM.  It wants to expand WFM’s appeal to a smaller, younger, more affluent audience, not steal traffic from WMT.

–the key to profitability in a distribution business is to turn inventory over rapidly, taking a small markup on each transaction.  This is surprisingly badly understood by most professional investors, as well as virtually all the financial press–and by WFM, as well.  This is one reason that as an investor I love distribution companies.

Low markups defend against competition and create customer loyalty; continual effort to keep the growth in inventory under the growth in sales creates positive operating leverage.

WFM appears to me to have chosen do pretty much the opposite–to take large markups on each transaction, a “strategy” that has stunted sales growth.  Inventory turns are higher for WFM than for other grocers, although I suspect that this is a function of differences in product mix.  In any event, something else (or, more likely, a bunch of other something elses) in WFM’s organizational structure is all messed up.  The income statement shows that its very fat gross margins are frittered away almost completely by high overhead expenses.

If I were AMZN, I’d figure I’d attack what I think is the abundant low-hanging fruit in operating inefficiency and lower food selling prices as I made gains there

–it’s very easy to lower prices.  It’s extremely hard to raise them again–a key reason that couponing is a favorite supermarket strategy.  So it would be crazy for a merchant to lower prices across the board on day one.  $.49 a pound bananas, displayed prominently by the store entrance, is aimed at setting customer expectations about pricing throughout the store.  It’s a symbol, a promise   …at this point, nothing more.

 

21st century retailing: my trip to Home Depot

This is another mountain-out-of-a molehill thing.

We have Toto toilets in our house.  Toto is the leading brand in Asia and has been making significant inroads in the US over close to two decades.  Yes, they’re the toilets that play music, heat the seat, double as a bidet and make fake urinating noises (a Japanese must)–but we just have plain old toilets.

The other day, I went to the local Home Depot, which, by the way, sells Toto toilets, to get a replacement part for one of ours.  A friendly employee showed me where the replacement parts were–all aftermarket brands, not Toto, but that was ok with me–and which was the right one. The replacement didn’t look much like the broken part, but the employee assured me that it would work.

It didn’t.  And, in fact, in looking back on my trip, the HD employee may, strictly speaking, have only told me that that was all they had.  If so, kind of embarrassing for me, since for most of my working life I was on the alert for verbal gymnastics aimed at papering over problems.

Rather than launch a telephone search for a plumbing supply store in the neighborhood that might carry the part I needed, I found it on Amazon.

 

Around the same time, I found I needed a replacement part for a Weber grill.  Same story.  HD sells Weber grills, but not replacement parts.  So, after a wasted trip to the local HD store, I ordered from AMZN.

 

What’s interesting about this?

In the early days of the internet, there was lots of speculation about the “long tail,” meaning that e-retailers like AMZN would make most of their money from selling obscure items that potential buyers couldn’t find in bricks-and-mortar stores.

A great story   …just not the case back then.  Just like bam, online exhibited the “heavy half” phenomenon, i.e., 80% of the business came from 20% of the items.

 

But maybe the long tail is beginning to come true.  It’s not because weird stuff that no one really wants has suddenly come into vogue.  Instead, I think computer-driven inventory control programs that eliminate slow-moving items from a store’s offerings may have gone too far.  Yes, carrying fewer items has the beneficial effect of requiring fewer employees and less floor space.  But at some point, the process begins to have negative consequences, as well.

For instance, it’s training me not to go to a physical DIY store, so I’m not passing by enticing end cap displays or being tempted by the sparkly high-margin junk arrayed along the checkout line.

 

My experience as an analyst has been that any cost-control measures always seem to go too far.  They work for a while, but the continual application of the same process somehow eventually ends up creating the opposite of the intended effect (yes, experience has made me a Hegelian, after all).  This may be what is starting to happen with inventory control programs that retailers use.

If I’m correct, this is another plus for AMZN.

 

thinking about retail: Dicks Sporting Goods (DKS)

DKS reported disappointing earnings Monday night.  Its stock dropped by 23% in Tuesday trading.  So far this year it has lost 49% of its value, in a market that’s up by 10%.  …this in spite of the bankruptcies of rivals Sports Authority and Gander Mountain, which should arguably have cleared the way for better results.

The obvious culprit here is Amazon (AMZN).

I’m sure that AMZN is a factor.  On the other hand, although AMZN is growing at 4x the +5% rate of annual expansion of sporting goods sales in the US, the online giant represents only about 4% of the total sporting goods market.  DKS alone is 50% bigger–and its bricks-and-mortar competition has shrunk considerably.  So online can’t be the whole story.

I think two other general factors are involved:

–Millennials vs. Boomers, with DKS, to my mind, clearly oriented toward Baby Boomers’ tastes.  This issue here is that although Boomers have more money than Millennials, their star is waning as Millennials’ is rising.

–a “normal” business cycle.  During most time periods and in most parts of the world, in my experience, consumers are constrained in their buying by the limits of their income.  As new households form and families rent/buy a residence, rent/mortgage and, sooner or later, things like furniture become significant purchase categories.  This means less money for other purchases–like new golf clubs.

From the late 1990s through 2007, however, that wasn’t the case. Universal availability of home equity loans enabled consumers to avoid budgeting and prioritizing purchases.  So the typical pattern of contraction in some retail categories while housing-related, expands was absent for an extended period.

Now it’s back.  My sense is Wall Street has yet to catch on.

As an investor, I’m not particularly interested in the sporting goods category.  But I think the pattern I see here isn’t an isolated phenomenon.  If I’m correct, we should be doubly careful of any traditional retailer.

 

 

new CEO for Tiffany (TIF)

TIF has languished for a number of years, for several reasons:

–the waning of the important Japanese market

–the shift of Chinese jewelry buyers away from foreign firms and toward local creations

–the recession, which lowered spending on jewelry worldwide

–perhaps most important, a lack of success in providing new designs for regular customers.

The company’s greatest strength is its brand name.  It’s unique in being able simultaneously to appeal to ultra-wealthy customers spending $10,000+ a pop and to ordinary people looking for a $200 trinket to have wrapped in the iconic blue box.

Oddly, in the discussion of TIF’s merchandising as being “tired” that I’ve been reading, analysts and (especially) reporters have been referring to this ability to serve low-end customers while still retaining the aura of exclusiveness that attracts the wealthy as a weakness.  Hard to understand.

At the same time, what’s being missed is the hole that has long existed in the TIF merchandise lineup–items that appeal to customers wanting to spend $2,000-$10,000. This middle ground is dominated by firms like Bulgari, which coincidentally have little presence among TIF’s customers in either of its market segments.

That’s wha’s so intriguing about the appointment of Allessendro Bogliolo, a former Bulgari executive, as TIF’s new CEO–something no one’s mentioning.

Whole Foods Market (WFM)–final round

As I pointed out last week, WFM has gross margins that are much higher than the average supermarket’s.  WFM also turns its inventory in a little less than two weeks, which is two or three times the rate of a typical grocery store.  Over the past several years, it has been generating over a billion dollars in annual cash flow.

On the other hand, sales are falling.  The largest use WFM has been making of the money it generates is to buy back stock ($2 billion worth over the past three years).  Its working capital management seems to produce much less cash for it than rivals–although this may be the result of an unusual product mix and/or worry that the current poor sales trend will continue.

In addition, it appears WFM is attempting to extend its brand downmarket with the opening of 365 stores–a tacit acknowledgement that its core high-end market is saturated.  In my experience, though, this strategy rarely works.  Its main effect is typically to degrade the upscale image of the main brand.  Tiffany is the only exception I can think of.

what interests Amazon (AMZN)

–WFM has a well-known brand name, that stands for healthy, high-quality, and ethical behavior.  But it also stands for “whole paycheck,” an attribute that AMZN can most likely eliminate without damaging the rest of the image

–an ironic plus, WFM doesn’t appear to have kept up with the times in pricing, computerization or inventory control.  So there’s arguably low-hanging fruit to be picked

–WFM has a physical distribution network that culminates in 430+ physical stores covering most major markets in the US

–the NPD Group, a leader in consumer marketing research, points out that:

—-WSM stores are located in areas that are younger and more affluent than average

—-52% of online grocery buyers are members of Amazon Prime, and therefore arguably disposed to by groceries through AMZN if the company had an adequate delivery mechanism

—-60% of Millennials bought at least one item from AMZN last year vs. 24% who bought something from WSM.  So AMZN has, at least on paper, the potential to deliver a large new audience to WFM

–according to a Morgan Stanley survey, which I read about in the Wall Street Journal, 62% of WSM’s current customers are already members of Amazon Prime.  Arguably, there’s a big opportunity for AMZN to increase the frequency/amount of WSM purchases through the Prime network.

my take

From its high in early 2015, the WFM had almost been cut in half–in a market that was rising by 15%–before Wall Street began to anticipate a couple of months ago that the company would be either restructured or sold.  Although I’m by no means an expert on WFM, that negative price action is hard to ignore.  So, too, the declining sales trend.

The picture that emerges to me is of an high-end retailer that has saturated its niche and whose chief product–healthy, but expensive, food–is being commoditized by rivals.  To date, management has marshaled no adequate response to this competitive threat.

AMZN provides a face-saving way for WSM to retain its counterculture self-image while turning over its market problem to more competent hands.