In Episode 5, David Fishman, Deputy CIO speaks with a retail industry expert to understand how the current pandemic has accelerated certain trends and outlines why investors should be paying attention.
In Episode 5, David Fishman, Deputy CIO speaks with a retail industry expert to understand how the current pandemic has accelerated certain trends and outlines why investors should be paying attention.
Jeffrey Addis:
Welcome to our podcast. My name is Jeffrey Addis. I am the President and Chief Operating Officer of Merganser Capital Management. Before we begin, a few important regulatory disclosures. This presentation is for informational purposes only and should not be considered as investment advice or a recommendation of any particular issuer, security, strategy, or investment product. Now on to our podcast. I am pleased to introduce David Fishman, our Deputy Chief Investment Officer.
David Fishman:
Welcome to the latest podcast from Merganser. We aim to produce timely and digestible information for our community of investors. Today is August 27th, 2020. We're going to follow a different format today. We're going to discuss the retail market, which impacts our portfolios through corporate debt holdings and commercial mortgage risk. Retail has been one of the sectors most impacted by the challenges of coronavirus. But unlike the restaurant or travel and leisure industries, which were booming before COVID, of course retail was facing many challenges before COVID. Mandatory lockdowns and closures were the last thing retail tenants and landlords needed. Today I have with me Scott Ginsberg from BrandCycle for discussion about the state of the retail sector. Scott, why don't you introduce yourself and your firm to our audience and share with us how you help retailers compete with Amazon.
Scott Ginsberg:
Absolutely, Dave, thank you for the time today. So again, it's Scott Ginsberg. I've been in digital marketing for a little bit longer than 20 years now, been recently within BrandCycle really focusing on e-commerce and the growth of online shopping. So really helping consumers as well as helping brands to capture more of the online market. One of the big areas that we've been focusing on is within the digital, just with Amazon and with Amazon and the growth that they've had, how do other brands compete and as more brands shift online, how do they employ strategies that can compete and take that market share from Amazon?
David Fishman:
Sounds really relevant to what's going on in the world today. So I wonder how many years did the coronavirus crisis speed up what was already happening in retail?
Scott Ginsberg:
Yeah, so I mean, I think that the sad reality is even prior to the coronavirus, this was already happening. So while it's hard to quantify a certain number, we were seeing traditional retailers already unfortunately filing chapter 11, starting to restructure. I think what the combination of, again, Amazon, north of 50% of the entire U.S. now has Prime. They're getting more comfortable with the online shopping, shipping, the reliance on needing to go to your physical store was already less of a need. Now you add to the fact that for a few months no one was leaving, it quickly forced consumers to only be able to shop on online. So we saw a lot of stores that just completely had to shut down, some doing curbside, but I'd say it did significant damage. And quite frankly, we don't even know exactly the number of years, but we do know in the short term, it's impacting just about every store in significant ways.
David Fishman:
It seems to me that a lot of the big box operators are emerging as winners with strong online platforms while many small businesses struggle. For instance, this quarter, Target posted an 80% jump in earnings while profit was up 75% at Lowe's. I read yesterday that Walmart, Amazon, Target, Home Depot, Lowe's, and Costco accounted for almost 30% of all retail sales in the quarter, which was up from about 26% last year. Now, in full disclosure, we're bond holders in all these companies, excluding Amazon, but I ask, can the small retailers survive?
Scott Ginsberg:
I do think they can. I think the challenge is, is they're going to need to significantly change how they do business. I think what we've already seen in retail is over the last 10 to 15 years, the categories like toy stores and electronics that had low margins to begin with just couldn't sustain having those brick and mortar presence anymore. Toys"R"Us is a good example, or even Circuit City and Lechmere. I think what's going to continue to happen is those sort of big box retailers like a Target or like a Walmart are going to continue to grow. I think it's going to be more of the niche type of retailers that are going to survive. But yeah, it is going to continue to squeeze some of the small retailers to think differently and to get more aggressive to continue to compete with some of those aggregators.
David Fishman:
Yeah, so retail concepts have come and gone over time. Retail bankruptcies are not new. New businesses do start up and expand, but the level of store closures is staggering. I saw a report from Bank of America this week with 9,000 store closures so far this year, almost the same amount as the full year last year. If you measure it in square feet, it's about 119 million square feet of closures so far this year versus under 110 million for the full year last year. What new concepts are being launched now that could offset these trends?
Scott Ginsberg:
Yeah, so it's going to continue. I feel like that's where retail again, and some of these stores are having trouble affording their lease, affording their inventory, affording their human capital to staff these stores. So you're already seeing some of the ones that were already suffering, obviously not survive. But I think what we're also seeing though is there is a rise in more of these direct to consumer brands. Brands like a Peloton or a Harry's razor. What they're starting to do is they're starting to look at it and pick up for some of these consumers or solve for that void that they're no longer getting.
So while I definitely think some of your traditional stores like the Lord & Taylors and Barneys aren't going to exist anymore, I think at the end of the day, consumers still like to engage with brands. They still like to shop. So we're going to see more of an influx of some of these brands that might not need a 5,000 square foot warehouse. They might be fine with more of a showcase display, but that's going to be really what's going to engage the consumers to be able to let them experience their brand.
David Fishman:
Well in this environment, retail real estate values have lagged the gains we've seen in other sectors for several years. In an aggregate, they started declining again. I saw a Real Capital Analytics report that retail was the only sector with year over year value declines. It was only small, less than 1%, which in my view is likely to get worse as the dearth of transactions start to pick up and we get better price transparency. Another data provider Reese said that rent growth had turned negative and vacancy rates have been increasing.
In the last cycle, retail vacancy rates peaked around 11%, but they barely came down in the following 10 years. They've really been bouncing around 10% for a while now. The last data point I want to give is that according to Trepp, retail delinquency rates increased from under 4% in February to almost 15% today as rent collections during lockdowns plummeted more than other sectors. Now 15% delinquency is below only hotels at about 22%. But the inverse of a 15% delinquency rate suggests to me that 85% of property owners still believe their property is viable. That feels high to me. Do you have a view on what percent of retail sales are ultimately headed for online and does that imply a lot more default?
Scott Ginsberg:
Yeah. I mean, I think unfortunately, I do think it's going to get worse before it gets better. We've already had seen prior to all of this brands struggling. There's no secret that you have a warehouse, it's easier to sell products versus having that physical storefront and all of the capital and all of the expenses that go with it. So that's only going to continue, and I feel like those brands that are savvy and had really early on embraced the online are continuing to do well. But unfortunately, I do think there will be more defaults. Most of the country and most of the world is still in some sort of lockdown. And I think even though we're starting to come out of it and more consumers are feeling comfortable, I think the idea of consumers, even in this shopping season, going to the mall and feeling confident isn't going to happen until hopefully a vaccine or we get back to more of a normal.
I think brands have survived. I think that they've definitely done what they can to be able to still work within what they can, but I think as things continue, unfortunately, I think some are going to continue to go the way of bankruptcy. And one thing I think that's interesting even about bankruptcy though is, we've seen brands that yes, they've closed stores, but they're doing it to truly restructure to then push more to do more online. So while I think it might end up helping some brands, unfortunately, I do think more delinquencies will happen until the world gets or the country gets back into more of a steady state.
David Fishman:
Do you think there's a retail format that's the most likely to survive? Is it a retailer that only exists online? Is it the power center format? Is it the big box format like a Home Depot? Is it the lifestyle center where you walk around the stores outside? Is it the traditional enclosed mall? Is it just a grocery anchored type? Do you have a view on that, Scott?
Scott Ginsberg:
Yeah. I think there's a couple things there. I do think the big box brands will be the ones that continue to gain market share. I mean, your stat earlier was pretty staggering as to how much growth they've picked up. But I think Target's a good example where they've got electronics, they've got sport and goods, they've got toys, and they also have essentials and they have food and they have clothing. So I think brands like that that already offer all of those to the consumer will only get more dominant. If I'm a consumer and I can just go to one stop and get everything I need, that's going to continue to be attractive to me.
I think these lifestyle centers I've also seen, they definitely have a good variety of stores. They do combine your restaurants with usually some sort of supermarket, but also a shopping experience. So I think those lifestyle centers tend to be, they're coming up in places that tend to be prime real estate. I think that model will continue. Again, unfortunately back to the malls, I think the malls will always have a presence, but I feel like the attractiveness unfortunately is starting to limit just given consumer preferences changing.
David Fishman:
Consumer preferences sure are changing fast. I wonder if you have any predictions for the coming back to school or holiday seasons?
Scott Ginsberg:
Yeah, so with holiday, that's definitely the biggest period of time for us. Obviously no one knows exactly what the economy will be like. We hope and assume that as things start to come back a little bit, that consumer spending stays at least flat to last year, but no one knows. But assuming it does, what we're seeing is inventory could be an issue. At the beginning of the pandemic, a lot of shipping windows became rather than two days, two weeks, because it was hard to get supply, it was hard to get the factories to produce those different products, and that's only continuing. So what we feel is that these brands, things that are already going to be hard to find are going to be that much harder to find.
So what we're predicting is that it's going to be an earlier shopping season and that consumers will be looking for a deal and that they'll be willing to shop, not just wait until Black Friday in November, but start that cycle earlier that we're even thinking come late October, we'll start to see some trends pick up of that holiday shopping. Back to school, that was different for us because again, with so much of the population doing virtual, clothing as a category did go down for us. Backpacks, some school essentials did go down. There's still, we have seen certain categories like electronics, home devices, home printers, laptops. That's grown to kind of offset some of the loss. But both seasons are different and we're focusing on is how do we salvage as much as possible of the two different holidays to ensure we're still successful.
David Fishman:
Well, certainly a lot of changes underfoot across the economy. Maybe none as ironic as the news that I think broke a couple of weeks ago, that Simon Property Group, again, full transparency, a name that we hold corporate debt exposure on, that Simon was in talks with Amazon to lease their old empty retail space. Do you have any view on what that can mean for the future of retail in the mall?
Scott Ginsberg:
Yeah, I feel like someday we'll look back and that'll be a Harvard Business Review study about, and Amazon in general and what they've been able to do. I mean, just think about it, they spent 20 years or 25 years basically eating the lunch of all these different mall stores, knocking out a lot of them, and then once they're gone, they then take up that valuable real estate because they want to get the logistics because they're near their consumers. So I feel like there's no stopping Amazon, and I do think at the end of the day, rather than leaving those spaces vacant, I think it's an interesting strategy. I read some articles that they think that having a warehouse will also help for shopping in the malls.
I don't know, that might be a little bit huff. But I think given it's already where we're at, I think it's going to continue. I think brands like Walmart that's getting more aggressive with their logistics, they might also follow suit. Where right now they're mostly standalone, potentially looking at that valuable mall real estate as well. But I think it is the ultimate irony. But given the situation, I get why the mall would do it, and I also get why Amazon would find that to be valuable. So I'm curious to see what negative or positive effect that has, but not surprising. And I do feel like there'll be other types of booze like that that are going to follow suit.
David Fishman:
Well as the CMBS analyst here, I'm glad to hear you say that it's valuable real estate, so that is reassuring. Thanks for your time today, Scott. I found this to be really interesting.
Scott Ginsberg:
Thank you, Dave. I appreciate it.
Jeffrey Addis:
This commentary contained or incorporated by reference certain forward-looking statements, which are based on various assumptions, some of which are beyond our control. Opinions and estimates offered constitute our judgment and are subject to change without notice as our statements of financial market trends, which are based on current market conditions. No part of this presentation may be reproduced in any form or referred to in any other publication without the express written permission of Merganser Capital Management. For more information, please visit our website at www.merganser.com. Thank you.