Motley Fool Hidden Gems Investing - Checking Out Retail’s Year

Episode Date: December 10, 2023

The key word for retail in 2022 was inventory. This year, it’s shrink. Deidre Woollard caught up with Motley Fool Senior Analyst Asit Sharma and Contributor Toby Bordelon to check out the retail landscape. They discuss: - How Americans are spending and changing their priorities. - The tech replacement cycle, and what that means for Best Buy. - A slowdown for Home Depot and Lowes. - Retail trends to watch in 2024. Tickers discussed: HD, LOW, BBY, LOVE, WRBY, LULU, NKE, UA Host: Deidre Woollard  Guest: Asit Sharma, Toby Bordelon Producer: Ricky Mulvey Engineers: Rick Engdahl, Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

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Whatever lies ahead, don't change your morning. Let your morning change you. Discover Coffee Plus on Nespresso.com. But the fact that there is no longer like a huge amount of inventory of these low-end chips sitting with manufacturers tells me that it's good conditions for those who are now looking to maybe replace a mouse that they bought during the pandemic when they were home, because it's been a couple of years. So maybe that's a trend that we'll see some life in 2024.

for. I'm Ricky Mulvey, and that's Motley Fool senior analyst Asit Sharma. Deidre Willard caught up with Asit and Motley Fool contributor Toby Bordelon to wrap up the year in retail. They discuss how spending trends changed and what that means for home improvement retailers, fast fashions comeback, and why everybody wants to be Lululemon. so let's start with one of the core stories of 2023 which is uh i've called before the kind of unsinkable consumer this the consumer just kept spending good news bad news whatever was coming its way you know we just all kept spending we kept going out now the good news for uh for the future is that inflation is going down but the bad news is you know student loan payments are back

There are some signs of a little consumer weakness. People are saving less. They're putting more on credit cards. They're using more buy now, pay later. So as you think about that, Asad, I'll start with you. How much are you worried about the consumer in the coming year? And how are you thinking about the consumer habits of the past year? Deidre, I'm looking at the year ahead as one of a reset for the consumer. I think there's some spending exhaustion out there. You noted factors that are driving a little bit more hesitancy on the part of the consumer. Those student loan payments starting up higher interest rates in general, which means that you've got a bigger payout to maintain your credit status if you're using credit cards to make those purchases. But I do think over the longer term, the fact that the U.S. economy has been able to pull off somewhat of a soft landing so far is a good sign for the intermediate term, even if we hit a slight recession next year and the consumer,

which has been supporting the economy, pulls back. I think longer term, the growth of the U.S. economy, the tightness of the job market are factors that are positive both for GDP growth and an eventual resumption of spend, even if it's like, you know, late 2024, 2025. Toby, how are you thinking about the consumer? Yeah, you know, I think there is, as I've said, some hesitancy for the consumer heading into the next year. But I also get the sense, or I have the sense, maybe this is incorrect, that a lot of the concerns we've heard about the economy from, you know, consumer sentiment, maybe not being all that great, that sort of thing, might just be a product of the price side of inflation

and people not thinking too much about the wage side of inflation. I mean, look at what the UAW won in the latest negotiation with automakers. That's a lot of extra money in those consumers' pockets, right? And I think part of the... When you ask consumers, are you concerned? They say, yes, I am. But it comes to the fact that you go to the grocery store and milk is more expensive. you don't maybe see the increase in your paycheck on a daily basis quite as much but when you do go to make these spending these choices you look at your savings account like oh there's some money there i can make this happen i do know my salary has gone up i can make this happen uh so i'm optimistic i think i'm optimistic there have been wage gains there have been income gains and i think

we're going to kind of see that play out. And is it going to be a boom? Probably not. But I'm just not convinced that we're going to see a big pullback from consumers. I think they're going to be pretty stable heading into 2024. Well, I think you mentioned something interesting there, which is that, yes, when you have those surveys, people say that they're concerned, but they're still spending. There's a disconnect between what they're worried about and what they're thinking about and their activity, which has continued even as they were worried, very worried at the peak of inflation. It didn't really, didn't really stop the behavior. I want to ask one more question about 2023 that I felt like 2022 was the year of

inventory, right? Every, every retailer was telling us, you know, we have an inventory problem, reducing inventory. Most of them in 2023, they knocked that out. But this year is, this has been the year of shrink. People talking about shoplifting, concerns of overall shrink. Shrink was the word I heard the most. Do you feel like retailers are reaching the end of kind of wrestling with that issue now as we head into a new year? I think that some retailers handle this issue much better than others. And some retailers are concentrated in areas which are going through more economic disruption. So they are dealing with, in some cases, organized theft and surprisingly haven't been prepared on how to prevent that. So shrink in terms of the biggest

news story of this year, which is just the theft of retail merchandise, is going to be less of a story in 2024. I think we've seen measures taken by a lot of mass retailers like Target, which aren't that obtrusive to the consumer, but they include just small steps like having security at night at closing or having more of a presence of security, not necessarily a lot of it, just more visible. And we have seen more of those irritating instances of things you wouldn't expect to be under lock and key suddenly behind the glass case with the key. You have to call the clerk to help you get a pack of shaving cartridges. We've seen some more of that with retailers. But I don't think it's going to be as much of a story in this coming

gear. It tends to be newsworthy just because it's something scary. Just as if you look at certain statistics of shoplifting over the past several decades, as an incidence that's down from decades ago, but we just see it much more on social media and the news. Not to say that it isn't getting bad in a few places. San Francisco is consistently pointed to as a retail area where you're seeing much more theft and brazen theft but overall i just don't think it's going to have quite the newsworthy feel that it did this year and i think retailers are handling it better i was curious toby what are your thoughts on yeah i i think that's right i'm not sure it's going to be a big issue heading into next year um and uh i like what

you said about the visibility right we see it more so it seems to be a bigger issue and you know call me skeptical but i wonder if in large not maybe not in large part but if part of this was retailers using as an excuse for some things our margins are going down oh it's because of shrinkage right um we can just use that as an excuse in the earnings call and people will buy that and so we won't have to you know and i'm sure it's was it a part of it sure um but if you highlight that is the issue that is beyond your control it's more of a bigger social issue it doesn't really speak to your business specifically uh you can kind of avoid blame a little bit for maybe those declining margins or maybe some bad decisions you made or you can avoid um outright telling people uh

our margins are down because our costs are up and that's not changing anytime soon so just deal with it right and this is a problem that can go away right and so you you leave investors with some optimism. You leave them thinking that, well, it's not entirely your fault. Maybe we'll cut them a little slack. And then maybe it gives you an excuse or some cover to exit some markets or close some stores that you might've wanted to close anyway. So I think it was a real issue, but I think it was also a convenient opportunity for some management teams to close down some stores and to maybe avoid some blame on the earnings calls. I have heard other people express that theory as well. You're definitely not alone on that. Let's talk a little bit about

the ways that consumers spent last year and what we think for next year, because there's another thing that we heard over and over in retail earnings was, you know, consumer discretionary is hard hit. So like it was a good year for grocery, good year for smaller items, bad year for big ticket items, especially anything related to your house. So not a great year for Home Depot, for Lowe's, not a great year for Best Buy. Electronics have been down. So I'm thinking about this two ways because the Home Depot and Lowe's thing, I feel like maybe we're going to start to see people spending more on projects, but it's so tied to the housing market that I worry about it. But with electronics, so much of the spending was during the pandemic. We're now

a few years out. I wonder if that's going to come back. Asad, I'll start with you. What are thinking about the big ticket spending? Yeah, I think that the big ticket spending is going to continue to be on hold. One beneficiary of that in the world of like Lowe's and Home Depot are the pro contractors. They're still in demand because while bigger projects are put on hold, there's still just a dearth of new housing. So what Home Depot's and Lowe's have to do now is to cater to where the demand is. And it's in those small contractors who aren't necessarily doing project work for people who own homes, but still out there working on construction projects. So they're a beneficiary of that. The other, I think, other side of that is maybe you're onto something. If

we're not spending on those big ticket items, where are we spending? I sort of follow the semiconductor industry, and there is in what are called super lagging edge fabs, so fabs that make a lot of low-end chips. These are the ones that are produced on six to eight-inch wafers, not those very small four-nanometer process cutting-edge chips you hear about, but the stuff that goes into consumer electronics. We were looking at a glut of those chips after the pandemic, and typically in a semiconductor cycle, when you have a glut, it takes two years to work off that oversupply. And guess what? We're about two years out of the peak of the pandemic. So, I'm starting to see some signs in the tea leaves that there is going to be an uptick of demand for

electronics, again, on the part of consumers. Now, that may be reading the picture backward, right? You look for consumer demand first and then see what the supply looks like. But the fact that there is no longer like a huge amount of inventory of these low-end chips sitting with manufacturers tells me that it's good conditions for those who are now looking to maybe replace a mouse that they bought during the pandemic when they were home because it's been a couple of years. So maybe that's a trend that we'll see some life in 2024. Interesting. Toby, how are you thinking about it? I know you've taken a look at Best Buy recently. yeah yeah i i think also it's right on that replacement cycle maybe coming up do i know

you know personally i i was one of the households that bought multiple laptops in the pandemic as the kids were doing school from home right um that was three years ago uh now do you need a laptop or a tablet for each child uh if they're back in school maybe not but they are getting a along on the two. So, you're going to look and say, maybe time for a new one. Let's replace one of those, right? So, we're getting to that point. Whether it happens this holiday season or not, we'll see. But we're certainly getting to that point, I think. And you noted Best Buy. Their earnings report was very interesting, Deidre, because they broke down their categories

and what they said is like, look, our big ticket items, like our appliances, one thing Best Buy has done recently is move towards your bigger kitchen and household appliances they sell there that wasn't moving as much that was down a little bit they talked about entertainment being up though right so people were spending on things like tvs um things like gaming consoles we saw the adobe analytics report this came out recently for for cyber monday um among the top products xbox playstations nintendo switches right so uh entertainment is still being uh um they're still receiving some some spending dollars from consumers, which I find interesting. The other thing I'll note on the Home Depot lows issue,

I think this kind of goes back to the pandemic too. And I think it might be less of a finance issue and more of an opportunity issue. If you look at both of those companies telling us their pro business was up more than the DIY business, well, what happens when you're working from home, right? You're spending more time at home. You see things that need to be done more because you're home more you have an opportunity to do them because you're home more uh so you're going to go to home depot loads you're going to get the stuff you're going to fix up that little thing that you might not have noticed before now you're going back to the office um you're homeless so you see it less and then you have less of opportunity to do that because

you're spending more time commuting right so i think that might be feeding into it as well just The lack of opportunity, the lack of desire to do some of these DIY projects is probably weighing on these retailers more so than the, I don't have money to do it. I'd rather spend my money on a new PlayStation, right? Because I'm more interested in entertainment right now. So I think we're partially seeing a changing consumer mix and priorities with where they're spending their money. Interesting, because part of it too was, you know, I think with retail, the other thing we saw is where the money got pulled and where it got pulled was toward travel and experiences and away from those big ticket items. So it's not I'm going to get a new refrigerator. It's I'm going to go to France. So, you know, definitely I've been wondering when when that ends as well. And sort of dovetailing on that, where we saw the spending was grocery, beauty, wellness, anything that was sort of repeatable and really sort of like enjoyed in the immediate moment. My impression is that that continues well on, especially even as the consumer maybe feels a little more pressure.

You know, it's the lipstick economy theory where people still want to reward themselves with the small stuff. What do you guys think about that? Yeah, I think the only thing that gets in the way of that, Deidre, is 100 to 200 basis points of the Fed pulling back. So, if we shift gears into reverse and the Fed eases, then I think that lipstick effect, which was made famous by Avon sales in the 60s, 70s, 80s, whenever there was a recession, those sales soared. I think people then pull back from the wellness and beauty spends, which are still affordable, right? You can do it in small increments. It makes you feel happy. But if there's a general sense in the economy that interest rates are easing,

you have a little bit more in your pocket, I think people pull away from that. But I don't see that happening anytime soon. If anything, I think the Fed maintains. And boy, those sales of companies that deal in beauty, as you had mentioned when we were preparing for this uh podcast episode are um you know that they're really strong right now yeah absolutely yeah it's um ulta beauty to throw one out there had a surprisingly good quarter um with healthy traffic they were talking about um you know they did note that uh the average ticket went down a little bit but the traffic was up right so people are going there more uh maybe maybe you're seeing a little bit of that what you talked about also a little bit of that pullback people aren't spending

quite as much but they're still going right and they're going more than they were before so overall it's it's a good thing I'm not sure I see anything Deidre that changes that either in the next year I don't see any major trends that would make people pull back too much but I think that is certainly something to look at and that falls into that experiential category we're talking about, right? I mean, beauty products are stuff, but it's a consumable, right? So, you're buying it for that experience, not for the thing to have and look at, right? So, it's definitely that sort of thing I think we're going to continue to see spending on, I think. Well, as we wrap up, let's talk about some trends that you're following for retail in 2024 and the companies that are leading

the way. Toby, let's start with you because I know you've talked a little bit about in our notes about kind of showroom shopping, which I think we've talked about a bit and sort of, it's really interesting to me the way that we've sort of changed how we think about the real estate of a store, because it's partly going in there to buy stuff, but it's not, we don't buy stuff the same way we did before. And I think that's changing. What do you think? I think it is too. There are a lot of new retailers out there where their store is really a place for you to come look, but you don't expect to take the product out with you right at the time. Now, Furniture has always been this way, right?

Higher-end furniture. But you have some of the brands like Lovesac leaning into that. You go to the store, you try it out. You have people who can walk you through the various designs and the various fabrics and all that. And then you get delivered to your house sometime later. Warby Parker, another one that comes to mind, eyeglasses, right? You go in, you can do an exam there. You don't have to.

But you can try on the glasses. You can see what they've got. and then you can buy it in store but you don't take it like they it ships from their main distribution center right so the store is really just a place for you to look and see and i think we've got some companies that are embracing that like consumers want to see they want to look they want to feel some of these things and touch them and you can lean into that right and you can with a nice combination of your online distribution network and some physical locations have a really efficient system uh that that works for that um and if you're looking for

companies like what would you want to think about uh for that type of shopping well um not just the retailers some of which you know may or may not be great uh businesses right now um ups fedex right how do you get it to your house it's the delivery it's the logistics networks so companies like that, I think are going to perhaps benefit as this trend continues and maybe grows. So I'm watching a couple of trends. One of the trends that I'm really interested in is, I'll just call this, everyone wants to be Lululemon. So there's a movement among those who manufacture goods to be perceived as sort of an athletic brand, a technical brand. Nike is very good at this. I'll note that Under Armour, which is like a turnaround stock just now,

their new CEO, Stephanie Lenartz, is really interested in bringing out the technical aspect of Under Armour's offerings. She's focusing on footwear. They have this great football boot, which in the United States, we call a soccer cleat. It's the Magnetico Pro. it's got like a $250 price point. I think more retailers are going to be involved in this trend where the manufacturer or brand, which may outsource, obviously, its footwear or other clothing, is trying to go towards a premium price point, but give you a technical edge that makes you better. Nike and Adidas both have many marathoners who are using their latest technology to promote their shoes in this instance. So that's one trend that's really interesting to me.

Let's see what happens with it. The other is, I think fast fashion is having a moment again. After supply chains broke down in COVID, it seemed like the end of that fast fashion trend. But we've seen the explosion of a new business model in companies like Taimou and Shein, which is confidentially filing to go public in the U.S. Temu, if you don't know this, is an online sort of version. It's a cross between a fast fashion website and TikTok. So these are influencer infused models, which have thousands of new products that are available every day. Only few of them are actually produced. And the sales are just amazing. Temu is on track to do $16 billion of revenue this year globally. It was just launched in the U.S. in late 2022. So it

sprung from nothing into this business worth tens of billions. Shein similarly has sales that are just a huge magnitude. And even Amazon is starting to work with clothing retailers to make sure they don't get left behind in this. So we'll see. I'm not sure the long-term economics of this business model really hold up. I'm sort of suspect, but it is a fascinating one to watch because it involves a demographic which is young, which is already savvy with social media. To your point, Deidre is very mobile savvy and isn't really into big ticket spending. You can buy items for as low as two bucks on some of these sites. So there are little points of pleasure, I think for the younger generation, but I just don't know about those unit economics over time.

As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow. Thank you.