Vern Gowdie – The Daily Reckoning (Australia) –
Traditional retail is under serious threat. People are gravitating towards alternatives like Amazon for one primary reason…to buy more for less.
Amazon is high-volume and low-margin, and it doesn’t have the property overheads that brick-and-mortar retailers do.
But life is never one-dimensional.
There are other factors at play. Factors that could cost yield-starved investors serious money.
The relentless pressure on retail margins has forced Warren Buffett to act. This headline, and the extract that follows, is from Fortune magazine on 16 February 2017:
‘Warren Buffett believes in America’s future but seems more doubtful about that of Walmart and other traditional retailers.
‘As recently as last summer, Buffett’s holdings in Walmart were worth $3 billion, and are now down to less than $100 million. The Oracle of Omaha first invested in the company in 2005.
‘Buffett himself seemed to take a dimmer view of traditional retail’s prospects at Berkshire’s annual meeting last year when he said of Amazon, “It is a big, big force and it has already disrupted plenty of people and it will disrupt more,” adding that many companies “have not figured the way to either participate in it, or to counter it.”
In the face of the Amazon onslaught, Walmart shares have gone nowhere for the past decade. Buffett’s decision appears to be a concession that the trend to cannibalise retail margins is here for the long term.
And with good reason.
This is from Business Insider on 3 January 2017:
‘Nearly every major department store, including Macy’s, Kohl’s, Walmart, and Sears, have collectively closed hundreds of stores over the last couple years to try and stem losses from unprofitable stores and the rise of ecommerce.
‘But the closures are far from over.
‘Macy’s has already said that it’s planning to close 100 stores, or about 15% of its fleet, in 2017. Sears is shuttering at least 30 Sears and Kmart by April, and additional closures are expected to be announced soon. CVS also said this month that it’s planning to shutdown 70 locations.
‘Mall stores like Aeropostale, which filed for bankruptcy in May, American Eagle, Chicos, Finish Line, Men’s Wearhouse, and The Children’s Place are also in the midst of multi-year plans to close stores.
‘Many more announcements like these are expected in the coming months.’
Aussie retailers are next in the firing line… The Australian, on Wednesday, 1 March 2017, ran an article titled: ‘Fears build as Amazon seeks warehouses’.
Here’s an extract:
‘Outgoing Wesfarmers chief executive Richard Goyder has repeatedly warned the US retailer will “eat all our breakfasts, lunches and dinners”, and the group’s entry could cost local retailers as much as $4 billion in sales.’
Investors are in for a mall-ing
Pardon the pun. It should be ‘mauling’. But this headline puts it into perspective.
Source: Business Insider
With the likes of Sears and Macy’s closing stores, shopping centres are losing anchor tenants. Without these big-name retailers to attract foot traffic, other retailers start feeling the pinch.
Recently, I was speaking with the manager of a major retail store on the Gold Coast — to protect their identity, I won’t disclose which one — and they said that business was not good. They were hoping it was a slow month, rather than a trend.
When anchor tenants identify a trend of falling sales, management’s standard response is to reduce expenses — cut staff numbers, and talk to centre management about a reduction in rent.
It’s this latter response that investors in retail REITs (Real Estate Investment Trusts) need to be aware of. When tenants negotiate rent relief, income distributions are going to be adversely impacted.
In addition to stagnating or falling rental income, there’s the role interest rates play in the income and capital equation.
Here’s a couple of charts of Scentre Group (the $23 billion spin-off from Westfield) and Charter Hall Retail REIT (a $1.7 billion fund):
Source: Yahoo Finance
Source: Yahoo Finance
In both cases, the unit prices peaked in July/August 2016.
|REIT||Price July 2016||Current Price||% return|
|Charter Hall||$4.90||$4.25||Minus 13%|
|REIT||Distribution Paid||As a % of July 2016 price||As a % of current price|
|Scentre||21.3 cents per unit||3.94%||4.95%|
|Charter Hall||28.2 cents per unit||5.75%||6.63%|
In the first half of 2016, investors were chasing yield due to the RBA cutting the cash rate from 2.0% to 1.5%.
What did the herd do? Rushed into higher-yielding options like REITs.
In July 2016, investors in Scentre bought an income stream of 3.9%. That has come with a capital cost, so far, of 20%. Not real bright…
Investors in Charter Hall have fared a little better. The 5.75% income stream they bought has only cost them 13% of their capital.
Whereas the 100 cents in the dollar in a term deposit is still earning 3%.
Term deposits may be boring, but, from where I’m sitting, they offer the best risk versus reward equation at this stage of the cycle. When the cycle turns — and it will — our cash is going to buy investments with very low risk and high reward…a much better equation, in my book.
The final word on this belongs to Warren Buffett:
‘…when you combine leverage and ignorance, you get some pretty interesting results.’
Editor, The Gowdie Letter