Last week’s retail sales data for April was better than expected across the board. Overall April sales were up 1.3% month over month versus expectations of a 0.9% rise. Gasoline and autos helped the headline number but the “control group” which excludes gasoline, auto, and building material sales comfortably exceeded expectations, up 0.9% month over month versus expectations of 0.4%.
The strong retail sales report showed that the consumer is holding up very well but that strength did not help the earnings reports from retail companies. A number of traditional department store retailers reported earnings that were disappointing and this led the retail sector to its worst weekly performance since 2011. Investors are wondering why the strong retail sales figures are not translating into retail sector earnings.
Some blamed the weather and challenges with the macro landscape as reasons for the disappointing earnings. Those of us who were managing assets when the internet was born think back to the initial concerns around the harm the internet could do to the ‘bricks and mortar’ retail business. Some of those concerns have been realized as traditional retailers such as Circuit City and others have gone out of business. This trend towards online purchasing is certainly real and it seems to be accelerating as the chart below illustrates.
The shift to online shopping is a major headwind for traditional retailers and makes investing in the retail space challenging. What is the best way to take advantage of this situation? Below we highlight some areas that could benefit from the shift to online shopping.
Online retailers – obvious choice to take advantage of online retail is to invest in the companies that are the leading online retailers. While there is one “elephant” in this category there are other companies that also sell products online. Investments can also be made in traditional retailers that are leaders in the shift to online.
High demand product makers – these are companies that manufacture products that people want to own and shoppers will buy them in any channel – online, brick & mortar, or specialty store. Athletic gear, a winter jacket, the latest tech gadget, or that high end leather bag are some of the products that are in high demand and the companies that produce these products should continue to perform well.
Discount retailers – everybody loves a bargain and there are many retailers in the discount space that are thriving. Whether it is a dollar store or an off the rack retailer this is a category where retail traffic, and sales, continue to grow.
Specialty Retailers – there are some products that you just don’t want to order online and the retailers that carry these products should perform well. Whether its shoes/sneakers that you want to try on, jewelry, or building materials like plywood and 2X4’s, there are just some products that shoppers do not purchase online. The retailers that sell these products currently have a niche that online cannot compete with and these companies should continue to remain attractive.
Restaurants – consumers continue to spend on food service and drinking places with sales in this category up 0.3% month on month in April. Many categories in this space are holding up well as consumers will always want their coffee, quick service sandwich, or a glass wine or beer.
Others in online retail channel – the strength in online retail is a beneficiary for others that participate in the online channel. Shoppers will pay for online purchases with credit so credit card companies should be a winner. To get the merchandise to the shopper it needs to be shipped. Cardboard box manufacturers, airlines, railroad, and truck companies stand to benefit from this as well.
As shown by the disappointing earnings from department store companies last week, the shift to online is having a negative effect on traditional retailers. There will still be companies that perform well in this environment but in the Dividend Income portfolio we have chosen to avoid this space. We do not hold any traditional retailers while we have several positions in the categories mentioned above to take advantage of the shift on online.
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