- We believe that many of the macro and micro headwinds experienced through 2013 will continue into 2014.
- Low correlations across apparel retailers and manufacturers provide opportunities to generate alpha through stock picking.
- Faced with structural and cyclical headwinds, apparel retailers will need global brand strength, enhanced technological capabilities and supply chain expertise to gain market share.
Recent data points across the consumer space have been mixed, and retailers and investors are struggling to sort through the noise to determine underlying demand. To recap 2013, apparel retailers underperformed other sectors within consumer discretionary from a sales and stock perspective given payroll tax headwinds and lack of fashion newness. December and January sales were worse than expected for many companies due in part to disruptive winter storms, though management teams provided a more positive view of February given more favorable weather and higher tax refunds driving spending in the back half of the month. From both a macro and micro perspective, we believe that the holiday season provides a useful prism through which to examine consumer behavior into 2014.
On the positive side, comparisons ease as we cycle the payroll tax increase in 2013, and the “wealth effect” (net equity gains in housing and stocks) should drive sustained strength in consumer confidence. Unfortunately, the negatives seem to outweigh the positives with 1) lower levels of growth in disposable income forcing allocations across spending categories; 2) the personal savings rate likely to rebound from near 20-year historical lows, thus eating into spending; 3) consumers’ reluctance to take on additional leverage despite increasing willingness by banks to lend; and 4) limited upward pressure on wages as hiring has lagged prior economic recoveries. On the first point, the “allocation nation” theme should continue to play out in 2014 with consumers spending more on durables (e.g., autos, home-related expenditures) versus non-durables. Even within non-durables categories, the ongoing spending shift towards accessories and away from apparel can be expected given less favorable weather through summer, less democratic fashion trends in the marketplace and a lack of seasonality in consumers’ wardrobes. With both structural and cyclical headwinds facing many apparel retailers today, we believe that global brand strength and supply chain expertise will be needed for companies to gain share going forward. Price (either every day or promotional) alone is not enough to drive sales, as evidenced by the heightened promotional environment and ensuing weakness in both mall traffic and total sales (including e-commerce) seen through the holiday period.
Looking across the consumer income demographic spectrum, the high-end consumer continues to outperform the low and middle-income brackets. The “wealth effect” has greatly impacted consumer confidence among upper-income consumers, and companies targeting these consumers have benefitted to a greater degree from higher tourism-driven spend (both in the U.S. and Europe). As it relates to the lower-income consumers, growth in disposable income is likely to remain under pressure given higher healthcare costs and lower government benefits (including food stamps and unemployment). In the very near term, higher home heating costs will also weigh on discretionary spend.
Exhibit 1: Rolling 12-month pairwise return correlations for large-cap apparel retail stocks
Sources: Columbia Management Investment Advisers, LLC, FactSet, IDC, MSCI Barra, S&P and Russell.
While there are many moving pieces in the “consumer discretionary spend” puzzle, we believe that many of the macro and micro headwinds experienced through 2013 will continue into 2014. It’s a share game — there will be winners and losers in terms of categories, brands and retailers from both a sales and valuation perspective. As we have seen over the past several years, the performance and valuation gap between the winners and losers has and should continue to widen. This environment of low correlations across apparel retailers and manufacturers (see Exhibit 1) provides investors an opportunity to generate alpha through stock picking. Going forward, retail stock outperformance is likely to be driven by those companies with strong global brands, enhanced technological capabilities and efficient supply chains. These companies are best able to generate upside to consensus earnings estimates and, in turn, garner a premium multiple as investors become more comfortable with their long-term sales and earnings growth prospects.