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Tuesday's earnings from Home Depot and former retail darling TJX highlight two important trends: the do-it-yourself (DIY) business shows no sign of deteriorating and discounters like TJX and Ross Stores are no longer "safe havens" from the decline in retail store sales.
It's hard to describe how strong Home Depot's earnings and
They got there by selling more--average ticket was up 3.9 percent, and they got more people in the store: transactions were up 1.6 percent. Wow.
Home Depot is riding the perfect wave. Everything is aligning for them:
1) they are increasing market share;
2) spending on home improvement is growing;
3) home prices are appreciating;
4) Household formation is finally growing again.
These are just the fundamentals. Home Depot also has the advantage of being in that small group of large companies I call "buyback monsters," companies that have been decreasing their shares outstanding for
Home Depot: buyback monster
2004: 2.3 billion
2010: 1.7 billion
2017: 1.3 billion
Home Depot cut its shares outstanding almost in half in the last 12 years. This means that—all other things being equal—Home Depot's earnings per share look almost 50 percent better than it would if they had the same shares in 2004.
Get it? Rising home prices + more households + more stock buybacks = Home Depot up 19 percent this year.
Sadly, such is not the case with discounters. A couple years ago, discounters were all the rage--TJX and Ross Stores were the saviors for store retailers. Other full-priced stores like Macy's and Nordstrom rushed to open off-price outlets.
Things change fast. Today TJX reported earnings slightly above expectations, but second quarter guidance was well below Street estimates. First quarter
It's the same story elsewhere. Store sales in Nordstrom's off-price brand--Nordstrom Rack--were DOWN 0.9 percent year-over-year, even though
Stocks again hit historic highs today. Stocks have been strong because risk has been lower recently. Earnings guidance for the year has been strong. The global economy is improving. And the geopolitical risk from Europe is much lower.
Traders have been complaining about the low volatility, but that's historically not a problem for markets — stocks can do fine during periods of low volatility.
Why are the markets in such a tight trading range? It's simple. Right now stocks are relatively pricey, so buyers are only modestly enthusiastic about buying more — many would rather wait for prices to drop and then buy more. The sellers are not enthusiastic about selling because they see the better earnings and improving
This is a perfect example of the law of supply and demand: Modestly higher demand coupled with little eagerness to sell (falling supply) means prices tend to drift upward in a tight range.
The master of this is Lowry's, the oldest technical analysis service in the United States, which has made supply and demand the cornerstone of its technical analysis for more than 70 years.
Here's what Lowry's said to clients this morning about the current market: "Bull markets accompanied by rising Demand and falling Supply historically carry a very low risk of failing."
What does carry a risk of failing? When traders start selling at an accelerating pace, and traders stop showing any interest in buying at lower prices. Lowry's said, for example, that this is what happened in 2007, when selling pressure began to trend higher in June 2007, about four months before the final market top in October 2007. Trader interest in buying also began dropping and was much lower by the time of the top
This is not what Lowry's is seeing now: Buying interest has been higher since November 2016, and selling pressure has been lower.
There are other positive indicators as well: Market breadth has been strong. Bull markets almost invariably end with increasingly selective buying interest. That is not happening: "[T]hese measures of market breadth suggest continued clear sailing ahead for the bull market."
Lowry's does note that another indicator — the number of stocks at 52-week highs — has been a bit weaker recently but says it has not yet reached a critical point.
Its conclusion: "[T]he probabilities still favor more months of
Analysts are not known for making bombastic comments, but this remark from Piper Jaffray Retail analyst Erinn E Murphy certainly has the ring of truth: "Q1 2017 Likely Marks A Historic Moment For North American Softlines."
A historic moment of truth? That's not too hyperbolic. Piper Jaffray believes Amazon "will have driven >100% of industry growth in Q1 by the time everything is tallied."
How is that even possible? Because Amazon is getting all of the incremental new business, and it's taking share away from everyone else. Even discounters may be showing cracks now.
It's not like the consumer isn't buying. I noted in my last post that retail sales grew better than 3 percent in 2016. But the shift in where they are buying is accelerating and has likely reached a tipping point.
April retail sales show that the trend toward online is very much intact, and the department stores continue to lose sales:
April Retail Sales
Dept. stores: down 3.7 percent
Online: up 11.9 percent
Restaurant/bars: up 3.9 percent
Furniture: up 3.8 percent
Notice that the trend toward going out to eat and drink is very much intact, as is furniture sales. No wonder Amazon is looking to expand into furniture.
J.C. Penney's CEO sounded the same note as Kohl's, saying: "We are pleased with our comp store sales for the combined March and April period, which improved significantly versus February."
He too reaffirmed full year earnings guidance for JCP at $0.40-$0.65. Never mind that's a pretty wide estimate: no one believes it anymore. Not with same store sales trends like these:
You combine rising inventories with traffic declines, and you have a big problem. Analysts have been cutting JCP yearly estimates for months, but it will likely be cut even more in the coming weeks:
January 1: $0.66
I recently called my old friend Ken Perkins for a preview on the earnings season for retailers, which starts in earnest Thursday with Macy's and Kohl's. Ken has been a retail consultant and analyst for many years as head of RetailMetrics.com. When I cheerfully asked, "Any signs of a bottom for these guys?," he said, "I don't see it" and then rattled off this depressing string of statistics:
His glum evaluation: "This could be the worst performance for the retailers since the Great Recession."
Yikes! We all know retail is in upheaval, but something has happened in the last few months. We seem to have reached some kind of tipping point. Retailers big and small have been beset by a plague of problems:
You might think that retail sales are collapsing, but they're not. The National Retail Federation estimates retail sales were up 3.8% in 2016. Internet Retailer, which analyzes online sales, has a similar figure. They estimate that e-commerce represented 13.3% of total retail sales in Q4 compared with 12.0% in Q4 of 2015. They factor out items not normally bought online, like automobiles, fuel, and bar and restaurant sales.
More important is the influence of Amazon. The total value of transactions from U.S. consumers on Amazon.com reached $147.0 billion in 2016, about $35 billion more than 2015 (these are estimates from Internet Retailer and ChannelAdvisor Corp.). They estimate that total online retail sales grew about $53 billion last year, to $394.8 billion from $341.7 billion in 2015.
That means that Amazon comprised 65.9% of the growth in U.S. online retail last year, and they separately estimate it was 27.4% of the increase in the total retail market.
Think about that. One company was a quarter of all growth in retail sales.
How do you compete against that?
In talking to retail traders, what I find most interesting is the almost universal belief that Amazon does not seem to care what it costs to be "top of mind," that is, they don't care how much they have to spend, they want you to think of them first. For everything. They want to be the place where you buy and the price to them is really secondary.
If that means being cheapest, or free delivery, or advertising, whatever top of mind means, they want to be that. They will make the investment in that relationship to be top of mind. Everything in retail is an outcome of that. Amazon is not very sensitive to margin. They are willing to spend anything to buy sales, and that crushes everyone below them.
To a certain extent, Wal-Mart is also willing to spend a lot to be top of mind to their clients.
What does this mean for other companies? Take Target--which is expected to do $70 billion in revenues in 2017, compared to an estimated $166 billion for Amazon, and nearly $500 billion for Wal-Mart. How do you compete when you are dealing with companies that have three to six times your revenues and are willing to do anything to increase sales? It's hard for Target--or Kroger, or anyone else--to keep up.
On top of that, add deflation, or bad weather--and it becomes tough to hit your numbers. There is no margin for error because of the pressure Amazon and Wal-Mart are putting on the business in terms of pricing and delivery.
So where does it end? It's not clear, but it doesn't end here. That's why I want to hear guidance from the retailers--full year guidance, not that it necessarily means too much because things are changing fast. There aren't many retailers who have a good sense of what their margins will be even a year from now, and certainly not five years from now.
But you can be sure some brave analysts are going to ask the One Big Question: does Amazon and Wal-Mart end up with all the business?
No. A number of retailers are holding up, including the home improvement group (Home Depot, Lowe's), the discounters (TJX, Ross Stores), select beauty companies (Ulta, E.L.F.), and a few specialty retailers that recently went public are also holding up well (Canada Goose, Floor & Decor).
But the overall trend is clear: if the whole industry is growing by $130 billion a year, Amazon is taking a huge chunk of that--more than a quarter. And they are taking market share from others.
What's it all mean? "In a free market economy, it's good to be the consumer, bad to be the retailer," Perkins concluded.
It also means that you can expect more mergers like Coach-Kate Spade deal, which makes sense in this context. Coach generates tremendous cash flow, but they have largely saturated North America. They can only grow by reinvesting cash flow into new businesses. There's not a lot of earnings growth, but the cash flow can be used to fund new businesses. The best strategy is to buy existing brands as cheap as possible and use their existing global reach marketing to expand.
And they are getting them cheaper. Soraya Benitez, retail analyst at Cougar Trading, noted that Kate Spade was bought at a multiple of 10 times trailing cash flow (EBIDTA), but the stock has traded at 15 x EBIDTA in the past. "There's a massive valuation reset going on," she noted.
Is the stock market priced for perfection? It sure is, but with these data points it makes sense for stocks to be pricey:
This is a rare confluence of events — lower risk right across the board. It's not surprising that world markets are at new highs:
Global stock markets
U.S.: historic high
Germany: historic high
France: multiyear high
Japan: 16-month high
Emerging markets (EEM): 23-month high
Is the U.S. market expensive? Sure, by historic standards. Stocks have a very good correlation with forward earnings estimates. According to FactSet, the forward P/E estimate for the S&P 500 — which includes the last eight months of this year and the first four months of 2018 — is 17.5 (2,396/$137.04 = 17.5). The 20-year average is 16.0, so the current estimate is above average, but not dramatically so.
It's also not surprising that with these kinds of data points we are getting markets at new highs, but traders are whining about the low volume and low volatility. Again, this is not shocking: prices are too high to make buyers enthusiastic, but sellers are not enthusiastic either because everyone believes that a modest drop in the market will only be met with more buying.