We are nearing the home stretch in the latest earnings season. The hurricane of information that arrives on of Wall Street every three months has not broken the markets. Perhaps it has even fueled the market's comeback from the correction a few weeks ago. There are important emerging themes that you have to be aware of as we approach the peak of the fourth quarter. Understanding the deeper issues beneath the news of the day is incredibly helpful to adjusting (or not adjusting) the portfolio into year-end.
Will Gas Savings Boost Consumer Spending?
Gas prices plunged about $0.33 in October, following an approximate $0.10 drop in September. Parts of the country are reporting gas prices below $3.00 per gallon. According to research firm Gasbuddy, if oil continues to average $80 a barrel (it appears set to fall a bit further), gas prices may fall a few cents more. Should oil be sustained below $78.00 per barrel, gas prices could be on a new downward trajectory into Black Friday and Cyber Monday.
The gas price decline is not being reflected in sales, margins, or outlooks of consumer companies. Post-earnings, none of the executives I have talked with has voiced optimism that the gas price decline in the U.S. would unlock spending power in the holidays, and in the first quarter of 2015. I continue to use "gas" as a search keyword in earnings call transcripts, to look for indications that consumer companies have experienced renewed traffic as a result of lower gas prices. No dice.
The data supports these observations. Consumer spending declined 0.2% in September, weaker than consensus forecasts. Spending advanced 0.5% in August, before the plunge in gas prices.
Maybe August spending trends, coupled with the highest reading on consumer confidence since July 2007, are signals of the spending power consumers are reluctant to unleash before the holidays. I am not willing to position clients based on that thesis just yet, but I am prepared to reverse course, should Walmart (WMT) mention quarter-to-date sales trends improvement next week in its earnings announcement.
Consumer Stocks I am Considering
A few consumer stocks that I would want exposure to, when consumers start to spend gas savings:
Target (TGT): I remain concerned with the company's trends in Canada, and I expect them to exit a good number of stores there in 2015. However, gas savings will be spent more aggressively in Target than Walmart, given the higher-income demographic that shops the chain.
TJX (TJX): Interestingly, the performance of the stock in the past couple of weeks hints at consumers spending their gas savings this holiday season. The consumer at Marshalls, armed with a few more dollars, will likely leave it in the cash register amid a stock-up mindset for basic apparel and sneakers for the family. Nike (NKE) sneakers dominate the Marshalls sales floor. Another popular stock-up brand is Hanesbrands (HBI), whose products are consistently out of stock at Walmart and Target.
What's Really Happening at Michael Kors & Coach
There is more going on at Michael Kors (KORS) and Coach (COH) than the notion that each have over-expanded and saturated the market for handbags, wristlets, and shoes. I continue to voice concern that Michael Kors is getting reckless with new site selection (openings in B/C rated malls), and is not receiving top-tier placement for men's products at department stores. Also, Coach's turnaround may never appear. Nevertheless, there are bigger trends to discuss:
China: Tourist traffic and local spending in China and Macau have weakened, due to geopolitical turmoil and the government's revised rules on gift-giving. Furthermore, digging into the China results from Ralph Lauren (RL), I found that they were driven by one-time factors. Core trends on the ground are softening in line with the macro data on the country.
Nike has been an outlier to the expanding number of consumers companies mentioning unimpressive sales in China.
Factory store channel: Ralph Lauren noted last week that traffic at its factory stores remained weak. Coach said the same thing. This hints at challenging third quarters and holiday guidance from fellow retailers Gap (GPS) and J Crew (JCG), and even chain restaurant Texas Roadhouse (THRX) which operates at outlets.
Consumer: New entrants have entered the accessories marketplace at lower price points, such as Polo Ralph Lauren, Zara, Forever 21, Aldo. Coach and Michael Kors are no longer luxury purchases, as the companies have invested in lower-priced lines to entice Middle America. Price points are under pressure. Investment spending on new store designs and technology is elevated for most players in retail, either apparel or large box. I'm not sure how a gas savings splurge could change this margin constraint materially in the ensuring quarter or two. That's why it's hard to invest in the sector long.
Basic Rules for Investing in Retailers
Observe a few basic rules when investing in retailers (and Nasdaq names) valued for growth. These names include Michael Kors, Lululemon (LULU), and Nike. By following these basics, you can avoid getting burned on a "disappointing" quarter of 20% sales and earnings-per-share growth.
- Same-store sales last four quarters: growth must be accelerating quarter-over-quarter. If Company X reports a 5% same-store sales increase in the first quarter, there has to be a series of new products and/or service initiatives on the way that will deliver a second-quarter same-store sales increase well north of 5%.
- Gross profit margin trajectory: expansion must be accelerating quarter-over-quarter. If Company X reports a 100-basis-point year-over-year improvement in second-quarter gross margin, the aforementioned initiatives to encourage sales acceleration (hopefully high-quality full-price sales) will have to lead to gross margin expansion well north of 100 basis points in the third quarter.
If you read the earnings call transcripts and do not get the sense these two qualifiers will be met, don't long the stock in the portfolio.