This commentary was originally sent to Action Alerts PLUS subscribers at 06:15 on Jan.5.
- After a year of playing victim, U.S.-based retailers have used up their excuse-mill, making selectivity that much more important.
- What a difference a year makes: after opening 2016 to broad-based turmoil, holiday sales figures will prove the ultimate litmus test that will either make or break brick and mortar retailers.
- Costco's (COST) strong December sales release overnight beating heightened expectations, deepening the wedge between the likes of the few Amazon (AMZN) -resistant business models -- i.e. J. Maxx (TJX) -- and the likes of Macy's (M) and Kohl's (KSS) . The latter two's stock prices plummeted over 10% in pre-market trading after both department stores reported awful results.
- With weather no longer an excuse, the strong dollar serving as a boon, the retail winners are ones whose business models are truly sustainable, and have unique value-add and event-driven situations.
Why Costco and TJX Remain Amazon-Resistant Brick and Mortar Retailers
We remain bullish on our brick & mortar retail names after digesting a tale of two cities: while Kohl's and Macy's traded 10% lower in after-hours following awful results which, in Macy's case, included another massive store closure and wave of layoffs, we remain bullish on T.J. Maxx. As we laid out in an earlier bulletin, T.J. Maxx stands to benefit from the excess inventory that it will be able to buy at fire-sale prices from Macy's, as the latter is short on cash and long on overstocked items that did not generate enough foot traffic to make shopping at the department store worth the consumers' while. Refer to our bulletin for our thesis on why TJX is Amazon-proof.
As Macy's and Kohl's turned into clear value traps overnight, Costco emerged from the holiday sales season not only unscathed but with accelerating momentum, which should deafen the bears and all but ensure a double-digit membership fee will occur sooner rather than later (i.e. within the first six months of the year and certainly the first three). The company -- which struggled to demonstrate same-store-sale (SSS or "comps") resiliency throughout most of 2016 -- carried its holiday sales momentum (which it alluded to after reporting strong results in the last two weeks of November) into the last month of the year, closing 2016 on a high note by reporting "core" SSS of over 3% with both price and traffic accelerating (+75 basis points and +200 basis points, respectively), handily beating consensus estimates for 2.5%, aligned with a 3% headline (reported) print.
We believe the company's strong results all but guarantee an impending fee hike (as a reminder, membership fees account for 90% of profits as the company uses competitively low prices to get people in the door) and are impressed not only by the resilience, but the ability to deliver such strong results amid a near-20% drop in tobacco (as the company cycles deflationary pricing headwinds), the aforementioned membership fee increase and potential for a special dividend.
What a Difference a Year Makes
One year ago, the stock market opened the year down a harsh 5%, halfway to the Dow Jones Industrial Index's worst 10-day start to a year in its 120-year history. In fact, the "benchmark rounding" conversation focused not on the exuberant "Dow 20,000" headline, but whether the blue-chip index would breach 15,000 (it found its low on Jan. 20 at 15,413). The S&P 500, meanwhile, shaved over $1 trillion in value within its first seven days of trading, during which Macy's emerged as the best-performing stock within the index, soaring 10% over the same period (more on this shortly).
The retailer's decision to cut over 4,300 jobs and close 36 stores following poor holiday sales caused investors to double down on a deep value trade (shares had been sliced in half in 2015) in an iconic brand, which appeared to be making difficult decisions (management committed to saving $400 million to help offset a "disappointing 2015"). This, plus the "strong American dollar", Macy's domestic presence, and a widely accepted excuse for weak holiday sales -- a historically warm holidays period (which, according to Macy's management at the time, was responsible for 80% of its sales decline) -- emerged as the rallying cry across nearly every brick & mortar retailer.
Layer on stacking fears of continued currency headwinds, macro turmoil (Chinese benchmarks opened up down 25% in first 10 days), draining consumer confidence (where pent-up demand from $1.99/gallon fuel prices zoomed right past consumer wallets and into 0.05% savings accounts), an overextended (peak) auto cycle and lack of direction from the Federal Reserve and every company trading above a mid-teens P/E multiple was put on the chopping block, irrespective of single-stock selectivity.
Flash forward (emphasis on flash) and we are looking at a retail landscape that has flipped itself on its head, despite an absolute reversal of macro- secular- and market-level fortunes, including a 75% rally in oil prices (stabilizing an entire masse region of consumers), a normal winter (relative to last year's "historically warm" holiday shopping season) and record-high U.S. dollar, which give retailers reason and rationale to deliver on long-awaited promises of elusive growth.
We will be out with commentary around a third uniquely idiosyncratic brick & mortar investment, Walgreens Boots Alliance (WBA) , which reported this morning and will include any incremental commentary from the critical conference call along with any incremental thoughts around Costco. We would be buyers of both COST and TJX on any post-open weakness.