Retail is hurting as more brick and mortar stores feel the pressure from online merchants and the rising costs of a physical presence. But three key areas present opportunities.
Although U.S. consumer spending is forecast to increase 2.5% this year—and consumer sentiment indicators are reaching levels not seen since the early 2000s—retail is troubled.
Consumer spending represents a whopping 70% of the U.S. economy, with retail about one third of that. However, shoppers’ growing preference for online purchases, the overbuilding of stores and rising interest rates have put retail under pressure.
Retail stocks are up 7% this year compared with a 6% gain for the S&P 500. But a deeper examination shows that nearly half of retail stocks are down for the year to date since some of the largest index constituents are e-commerce only and have double-digit returns that offset declines from traditional retailers.
So where does this leave the outlook for retail stocks? And where are the opportunities?
Consumer companies with favorable secular growth.
Online-only retailers are gaining share of total retail transactions yet they account for only 8% of the total which means they have room to increase penetration. Additionally, payment networks are still gaining share versus cash and actually benefit from online growth. These secular growth industries are well positioned to grow as traditional retailers struggle.
Second-order effects on store traffic and inventory.
Companies depending on mall traffic will likely feel the impact of store closures nearby—even if their own businesses are solidly profitable. Consumer products companies selling wares from T-shirts to shoes to cosmetics may suffer as liquidating stores redistribute inventories to other stores, reducing new orders or marking down inventories for quick sales, thereby suppressing prices.
The bottom line: a focus on customer captivity, recurring revenue and secular growth while avoiding second order impacts should reduce risks and lead to better returns.