Fri, 29 Nov 2013
As online purchasing becomes the norm among consumers, many retailers are increasing promotional activity and engaging in price wars to drive store traffic, says Morningstar's R.J. Hottovy.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I am here today with R.J. Hottovy. He is Morningstar's director of consumer equity research. We're going to look at the holiday shopping season and see who is well-positioned.
R.J., thanks for joining me today.
R.J. Hottovy: Thanks for having me, Jeremy.
Glaser: As we look at Black Friday, this year it seems to be inching ever so closer into Thursday. Why are retailers putting so much emphasis on these couple of days here? Is it really that important to their holiday bottom line?
Hottovy: We're only a few years away from having Black Friday in the summer at this point. But I think the motivation for getting out there as soon as you can really stems from the evolution we've seen in the retail space the last couple of years, with consumers more and more embracing e-commerce, and more specifically this year mobile commerce, with being able to shop anywhere, anytime. It's important for retailers to find still an occasion to drive people into stores, and so I think Black Friday still is that event for a lot of retailers. That's why you see that creep up into Thanksgiving and even earlier at this point, too. It's really to combat with the omnichannel movement that we've seen in the retail space.
Glaser: Best Buy and some other management teams have talked a lot about this being a very promotional holiday period, that they expect to have a lot of sales. Does that ring true to you? Have you seen that across a lot of the different retailers?
Hottovy: Yes, absolutely, that's something that we've been very cognizant of. I don't think it's necessarily just this holiday season in general, but I think what we've seen in the last couple of years is certainly consolidation in the retail space, whether it be Amazon taking share from traditional bricks-and-mortar retailers, or the large mass merchants like a Costco or Wal-Mart consolidating from smaller mom-and-pop shops.
Once you get larger players competing with one another, it really comes down to a battle of pricing there, too. These [companies] want to capture additional market share, and ultimately it's going to lead to lot of price competition. You no longer can take share from some of the smaller players, and really that leads to lot of price wars. I think this year will be a very promotional holiday season, and a lot of that does stem from industry consolidation. But I do think that's going to persist in the years to come, too. I don't think this is a one-quarter or even a one-year type of event. I think that promotional activity is here to stay and kind of plays into some of our longer-term thesis on margin contraction in the retail space.
Glaser: Maybe you shouldn't read too much into this being a sign of weak consumer spending or the lack of consumer strength, and there are some other issues at play here, too?
Hottovy: I think you could also point to this year, what we have seen as 2013 has progressed is, I think we have seen increasing pressure on particularly that lower- to middle-income consumer. At the beginning of the year they had been starting to face payroll-tax increases; more recently we've seen a pullback in spending just based on uncertainty with the Affordable Care Act. And I think that that combination certainly has exacerbated the promotional environment, as well, in addition to the consolidation that we've seen in the retail space. Right now that lower- to middle-income consumer is being very value-conscious and really does shopping on a lot of necessity needs and doesn't have a lot of discretionary spending power.
Glaser: What categories do you expect to be popular through the holiday shopping season? What are people going to be picking up?
Hottovy: I think it differs again for the lower- to middle-income consumer versus the high-end consumer. The high-end, I think we're looking at two categories in particular. I think consumer electronics, particularly video games just because we're in the midst of a new video game console launch with both the new Microsoft Xbox and new Sony PlayStation slated to launch right around now, so I think that will be a key category. We've seen portable electronics like tablet devices always being a big product category, as well.
I also think home furnishings will be a key category for the upper-end consumer. We've seen the U.S. housing market recovery. We've seen some benefits from the home-improvement retailers. Usually there's a little bit of a tailwind right after that with home-furnishing retailers. Things for home decor, home entertainment, I think those categories will do very well on the high end.
On the lower end, I think it's going to be a tough period, and there are not a lot of categories to point to. Again, those consumers are really looking to stretch their household budgets and really spending more on consumable, everyday staples items than anything else.
Glaser: How about apparel?
Hottovy: Apparel is an interesting one. I think that there's always room for it within the space, but we've seen a lot of that shift to online or gift cards, too. But apparel has always got a place in the holiday season.
Glaser: Given those trends, do you think retailers are well-positioned going into the shopping season?
Hottovy: Yes, it's tough to actually point out. I think you have to separate from which retailers are well-positioned heading into the season compared with valuation. Right now, if you look across the consumer cyclical universe, we find that it's about 8% overvalued, given the impressive market run we've had this past year. We certainly think that there's a disconnect between the long-term outlook for lot of these companies and what's baked into current prices at this point.
One name that does stick out to us in particular and kind of plays into this idea that we are seeing a lot more people embrace e-commerce is a name like eBay, which I think there is a misconception about this name being kind of a second fiddle to Amazon, when really the company has done a great job diversifying its business. It has got a wide network of users, a great portfolio of technology tools, and obviously a lot of payment services with PayPal. We think that becomes the partner of choice for a lot of bricks-and-mortar retailers, who frankly have had some struggles building out their own e-commerce channel and will look eBay to partner with them to better compete with the likes of Amazon and some of the other mass merchants out there. I don't think that that opportunity has been fully priced in and think that the market still views the company as an online auction business when it's anything but at this point.
Glaser: Let's dive into Amazon a little bit more then, and e-commerce generally. Obviously, it is a growing share. Do you think that the bricks-and-mortar retailers are going to be able to fight back somewhat, kind of get rid of some of the showrooming, where people are just looking at the products at the store and then buying them online? What are they doing to combat this, and is this just a terminally losing battle for them?
Hottovy: I think it depends on what product category you operate in. I think on one end of the spectrum you have home improvement, auto-parts retail, and, to even a lesser extent, pet supplies, where there is something about that business, whether it be the specialized nature of the product, whether or not you need a sales associate to help you out with, the service component with the pet businesses there, or even in some cases a difficult-to-ship product. I think those have some protection within the greater e-commerce spectrum.
In the middle is apparel, where there is always going to be room for some physical apparel stores because it is a part of an experience, the shopping aspect of that, but ultimately the final purchase price might be made elsewhere outside the store. So, I think it's kind of a combination there.
On the far end of the spectrum are names like consumer electronics and office products, which are very commoditized products, where no matter what level of service or in-store experience, consumers just want the lowest price, and if you can't give that to them, they are going to make their purchase elsewhere.
I think Best Buy has done a good job in terms of cost-cutting this year and doing some really innovative things to bring people back into the stores, whether it be trade-in programs for tablet devices or its store-within-a-store partnerships with the likes of Samsung, Microsoft, and even Google. But at the end of the day consumers will make that final purchase price wherever they can get the lowest price unless [the stores] can offer it. That's going to be a difficult proposition for the likes of Best Buy, and I think that the price-matching phenomenon that we've seen a lot of retailers adopt is here to stay, and it's going to last well beyond this year's holiday season.
Glaser: R,J,, thanks for your thoughts today.
Hottovy: Thanks, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser.