With the peak of earnings season and Black Friday in the rear view mirror, we spent Cyber Monday checking up on major retailers that have held earnings calls in the fourth calendar quarter of 2019. The winter holidays go hand in hand with consumer spending, making retail top of mind for investors with a cautious view of markets that have been buoyed by consumption despite headwinds from the storm of macroeconomic and geopolitical uncertainty.
First, we present an analysis of the Retailing GICS Industry Group that is rooted in Amenity’s NLP models focused on the underlying fundamental sentiment of earnings calls. We aggregate Amenity Scores into an industry view that confirms a significant bifurcation between small and large retail operations. Detailed statistics are provided for 32 of 40 retailers with market caps >$5 billion that have already reported earnings this quarter. A full accounting of the underlying data at the company level is available in an appendix.
Second, we offer context for two widely followed retailers: Target Corporation (TGT) and The TJX Companies, Inc. (TJX). TGT delivered best in class results thanks in no small part to its masterful execution of a transformation plan that has yielded a commensurate track record of Amenity Scores and share prices. TJX is seen as a defensive play that is insulated from trade wars, though we offer evidence to suggest there may be tariff risks emerging that have not yet been fully digested by markets. (Previously identified trade war exposures can be found in our archive.)
As the winter holidays approach, the health of retail is top of mind against a complex macro economic backdrop. The waters to be navigated are choppy: accelerating competition from new entrants and innovating peers, the continued growth of e-commerce versus brick-and-mortar, fresh plays for grocery, emerging subscription programs, expansions in direct-to-consumer and private label offerings, and changing consumer preferences that favor new formats and more sustainable products make it more difficult than ever for retailers to survive without evolution.
The bifurcations between retailers continue to widen along multiple lines. Initiatives focused on omni-channel and convenience have been paying off, leaving us to ponder the fate of alternative business models. Tariff exposure has forced some retailers to take scalpels and sledgehammers to their cost structures; some have passed the burden on to consumers while others have fallen on the sword. And while retailers have benefitted from healthy consumption driven by the lowest unemployment rate in 50 years, markets are rightfully curious on the heels of sluggish October retail sales figures released by the Commerce Department on 15 November.
Amenity’s NLP models identify yet another bifurcation between retailers – namely, in the fundamental sentiment expressed by management teams and analysts on earnings calls. As a barometer for the health of the industry, we aggregate company level Amenity Scores to calculate average Amenity Score for the basket of firms that comprise the Retailing GICS Industry Group over time. We present this data in the figure below alongside the MSCI World Retailing Index, which captures mid- and large-cap retailers in the Retailing GICS Industry Group. While it may be unsurprising to see the average Amenity Score track in line with the index given the composition of the basket, evidence of sustained fissures in retail earnings calls compelled deeper scrutiny.
Since the beginning of the sample from 2017 to today, we observe a sustained positive trend among retailers at the aggregate level (in blue). Compared to an average Amenity Score of 15 for all companies in our universe over the same period (>9,000 companies globally), the underlying sentiment appears favorable. Movements of the MSCI World Retailing Index (in red) appear to track in line with industry sentiment, particularly in terms of the timing of directional shifts. However, we note a divergence in 2019 where the Index rallies more aggressively than sentiment. (This may be a healthy reminder that we are in a bull market driven more by multiple than earnings expansion...).
The narrative of struggling retailers encouraged us to break down retailers in tranches to assess whether sentiment gone sideways is widespread or concentrated. With foreknowledge of revolutions underway, one line of inquiry led us to segment by market capitalization. Below, we plot the aggregate sentiment of retailers with market caps under (in purple) and over (in green) $5 billion. This confirms our hypothesis that economies of scale have been lifelines to large retail players seeking to transform their businesses, which we see reflected in the sentiment expressed.
What we observe over the last three years is a positive resurgence by retailers in 2018 followed by a steeper than average decline for small- and mid-cap retailers in 2019. This aligns with the increasing impact of tariffs and trade wars that have weighed heavily on retailers that do not have the operational scope to absorb or pass on increases in costs. While we see material improvement in the underlying sentiment of smaller retailers and a negative turn for larger retailers in 2H19, it is far from enough to close the gap.
Shifting our analysis to the company level, we examined Amenity Scores for the universe of retailers with market capitalizations over $5 billion. We provide the top and bottom five companies ranked by their last Amenity Score and the last change in their Amenity Score in the table below as a brief summary of our findings. For convenience and further exploration, we include a full table of data for 32 of the 40 retailers with market caps greater than $5 billion that have reported this quarter in the Appendix.
We find that the majority of the companies in the top and bottom five positions ranked by both Amenity Score and most recent change in Amenity Score have market capitalizations over $5 billion. This concurrently demonstrates the advantages of scale and the fact that there are bifurcations among large retailers as well. More notable is the fact that there are a number of smaller retailers who make it into the top five in each category. Foot Locker (FL) and Dick’s Sporting Goods (DKS) both put up stronger than expected performance this quarter, though FL shares took a dip on soft holiday guidance while DKS shares soared on boosted guidance for the full year.
Target’s pack leader position when ranked by Amenity Score should come as little surprise to anyone following the company, which has recently been reaping the benefits of years of effort to transform its e-commerce and delivery infrastructure, rationalize its store footprints, experiment with private labeling, and launch a new loyalty program. The quarterly performance TGT has posted shows strong results with solid comps and profitable growth that have kept the analyst and investor community happy as clams.
We visualize the sustained positivity of TGT’s Amenity Score in the figure below (in blue), which compares favorably to the retail average (in purple). The share price response is clearly visible in the last year (grey).
The positive trend in TGT’s underlying sentiment is the result of a multiple year business initiative that has seen management successfully transform more than 1,800 stores into pickup and fulfillment centers while substantially growing comps, especially in digital channels. All told, management set a high bar, met it, and continues to deliver profitable growth. The positive performance and outlook are reflected in the recent history of sentiment expressed about business fundamentals on earnings calls and the corresponding share price response.
TJX is another retailer that has demonstrated skilled execution and been a stable performer in the expectations game (the company has not missed EPS consensus estimates in five years). As the largest off-price retailer with more than 3,000 stores globally that market brand names at 20-60% discounts, TJX benefits from disruption with a one-two punch: (1) shake ups in traditional retail create buying opportunities from a network of 21,000 vendors in 100 countries to build inventory that drives future sales and (2) e-commerce players fail to compete with similarly diverse goods and the bargain “treasure hunting” experience without higher costs. As a result, TJX has historically been able to gain from the struggles of others. The proof is in the pudding: TJX has improved comps for 23 years with steady margins and a consistent capital returns program while growing its store count to more than 4,500 while upstream retail competitors shrink their footprint.
The flexibility of TJX’s business model allows the company to withstand rising prices for longer than most retailers, which only serves to increase TJX’s value proposition and competitive moats. Against that backdrop, TJX is thought to be well insulated from tariffs due to its late stage position in the value chain and its minimal direct sourcing of tariffed goods. (Estimates suggest tariffed goods account for ~10% of inventory.) However, we note that tariffs have been discussed in recent earnings calls and that our Deception Model detected an uptick in deception in response to tariff related questions over the last three earnings calls. The figure below visualizes our findings with TJX’s Deception Score (in red), deceptive event count (in blue), and the amount of deception related to tariffs (in purple).
We believe evidence of increasing deception related to tariffs may complicate the safe haven status awarded to TJX by investors in the midst of a trade war. On the latest earnings call, management expressed uncertainty about tariff implications in 2021 and hinted at an impact on Q4 guidance that was unquantified. While tariffs offer something of a tailwind to TJX by making inventory available at advantageous buying points from retailers in a tariff squeeze, it is unclear how TJX would respond to other off-price competitors (Ross Stores (ROST) and Burlington Stores (BURL)) taking pricing actions should tariff exposure ramp further. With that in mind, conveying an uncertain tone on the impact of tariffs is a strange outfit for TJX wear when they are the heir apparent to positive externalities from the effects of trade wars on competitors. Such conceptual puzzles will have to be reconciled by TJX investors. To aide in this endeavour, we provide illustrative deceptive commentary related to tariffs from TJX’s last three calls below.
"It remains to be seen what happens with the vendor and competitor pricing, consumer demand potential tariff pass-throughs, and we have so much of fiscal '21 that is not committed to versus currently, where we have the visibility for this fourth quarter… So I have to tell you that for next year, it's a bit of a wait and see, again, until we start to get a little closer to that time period and see what happens with the vendors."
"And so as a result, when you go into next year -- again, this is why we are apprehensive about saying that we can mitigate the tariffs because it could be a challenge based on -- the lack of visibility that we have right now is just having us on the standby-to-standby mode."
"And so we're in the, I think, best position to be able to moderate any risk and not even have to make retailing decisions till we see what happens around us."
"I mean, good questions, but we really don't have any more information on that..."
Additional deceptive commentary is contained in each call. If interested in this data, email: email@example.com.
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This communication does not represent investment advice. Transcript text provided by FACTSET and S&P Global Market Intelligence.
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