Opus News & Insights

Saturday, June 4, 2016

opus capital managementBack in the 1990s, the biggest problem malls had was the mallrat, which was popularized in the eponymous cult classic. Despite their enthusiasm, mallrats loitered in crowded stores with no shopping agenda, and took up valuable space at the food court as well as autonomous units for mid-mall snacking. Shopkeepers feared the deleterious effects of mallrats on commerce, and tried to eliminate their presence through aggressive policing.

Fast forward 20 years, and many malls are desperate for patrons of any sort. Despite a tailwind from lower prices at the pump (though this has recently started to shift), Consumer Discretionary stocks have taken it on the chin this quarter. So far this quarter, the sector is the only negative performer in the Russell 2000 Value (R2KV), down over 3% versus a 3% gain for the R2KV.

The carnage is much worse in certain areas. Diversified Retail is down over 14%, both Luxury Items and Specialty Retail are off over 13%, and Textiles, Apparel and Shoes are down over 10%. Even restaurants, which heretofore have been immune from the malaise, are lower by over 6%.
Both large retailers like Macy’s (though now just around $10 billion in market cap, given its recent slide) and smaller mall-based retailers have cited declining mall traffic as the primary cause for their recent earnings and guidance disappointments.

There are multiple factors that have conspired to make the consumer callow as it relates to spending via traditional channels. First, at a macro level, we have seen an increasing share of consumers’ wallets dedicated to necessities, i.e., medical care and staples. The following graph from Pew Charitable Trust shows the increase in consumer spending on non-discretionary items:

opus capital management

From a demographic perspective, the rise of the millennials has caused a shift from an interest in goods to experiences. While we hear this anecdotally, there is also evidence supporting this contention, and the strong performance of certain industries within consumer, e.g., Casinos (+4%), Entertainment (+35%), Hotels (+1%), provides some corroboration.

Finally, disruptive competition has appeared in the form of the “Amazonification” of retail. A few graphs from The Economist demonstrate the burgeoning power of the online retailer relative to its brick-and-mortar competitors. While Amazon’s competition has tried to adapt by rolling out online shopping, the ecommerce portion of the “omni-channel” that is often cited by management, the mere presence of Amazon has changed the game in many ways.

opus capital management
While in isolation ecommerce may generate high returns, it often cannibalizes sales from brick- and-mortar locations, and serves to undermine the operating leverage for the retailer. Many companies have responded by attempting to rationalize store bases and close under performers, but, for some, it has not been enough, and a number of traditional retailers have filed for bankruptcy.

In terms of our portfolios, we have not been immune from the weakness we have seen in mall-based retailers. However, we certainly consider this secular headwind when testing our investment thesis for companies in the consumer area, and tend to favor those names that are able to mitigate this risk or that operate in more favorable areas within consumer discretionary.

While a sequel for Mallrats is in the making, it is unclear if malls themselves and the iconic names that comprise these monuments to consumerism will have a revival as well, or rather if a bloodbath ensues.

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Michael R. Knapke
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