Slower consumer growth in 2012 is not fully reflected in valuations, and we remain selective and focused on structural winners.
--Few outright bargains exist in the consumer cyclical sector, and near-term risk might remain to the downside.
--A fierce fight for consumers' holiday spend supports our long-term views for the retail space.
--E-commerce continues to disrupt the traditional electronics retail business model.
Few Outright Bargains Are Present in the Consumer Cyclical Sector, and
Near-Term Risk Might Remain to the Downside
We're still concerned about lackluster economic growth and the increased reliance on the high-end consumer (consistent with our "Tale of Two Recoveries" theme), which could result in near-term volatility in sales and profits. Additionally, for those firms with significant international exposure, sovereign debt issues in Europe have clouded the 2012 outlook, and investors are unlikely to reward companies for issuing aggressive forecasts at this point. Meanwhile, general macroeconomic conditions in the United States remain uninspiring, with stagnant unemployment levels, elevated year-over-year gasoline prices, rising Consumer Price Index readings (up more than 3% year over year), waning consumer confidence, and ongoing fiscal debates which could curtail government spending in the coming years.
Despite such overhangs, we peg the average price/fair value ratio for our retail coverage universe at 0.98. There are few outright bargains, though we continue to focus on value, differentiated products/services, and later-cycle categories such as men's apparel and home, which may strengthen as the recession cycles. We would become more interested if the market were to trade down another 10%, but we're quick to gravitate toward firms with established economic moats, which might be in a better relative position to withstand potential near-term volatility. Notably, we generally bake in a deceleration in retail sales in 2012 at this point--roughly consistent with U.S. gross domestic product trends--with stable pricing and selective promotional activity (amid lower comparable-store inventory levels) as a partial offset to slowing consumer spending.
Fierce Fight for Consumers Holiday Spend Supports Our Long-Term Views for the Retail Space
Looking at the 2011 holiday season, doorbuster and heavy promotional ads were prevalent across retail, similar to prior years. However, this year the "earlier store hours" arms race was escalated, with openings beginning on Thanksgiving Day instead of the typical "Friday morning after" store openings that had been the case in the past. For example, Wal-Mart Stories WMT started the race, deciding to start holiday deals on Thanksgiving night at 10:00 p.m. Other retailers such as Target TGT and Best Buy BBY, to name a few, retaliated with their own earlier hours, with most choosing Friday at midnight. Even Dollar General DG entered the fray and opened its doors at 7:00 a.m. Thanksgiving morning.
Although the early hours succeeded in drawing in customers on Black Friday, we highlight two overarching themes which support our, "Tale of Two Recoveries" thesis. One, holiday sales programs actually signal a weaker consumer, and two, none of these holiday promotions or timing shifts provides sustained competitive advantages, in our view.
First, the idea of aggressive holiday sales programs supports our long-term views of the retail space, while actually signaling a weaker consumer. We continue to see three particular headwinds mounting, which are likely to result in muted gains for retailers. One, we believe the retail sector is simply overstored, and Amazon.com AMZN makes the saturation problem worse. Two, retail is no longer fragmented for easy share gains against weaker local or regional players but remains far from a margin-neutral oligopoly structure, so we expect destructive pricing wars to develop. Three, households and (soon) government deleveraging in Europe and the United States will occur during the next decade.