In March 2020, restaurant reservations were canceled, vacations put on hold, and social distancing quickly became the norm. Consumer spending rapidly shifted into pantry-loading, electronics to support working from home, and home renovations.
Even as the pandemic continues today, many consumer patterns are shifting back to pre-COVID patterns. As consumer behavior continues to normalize, we expect that spending will return to prepandemic trends between goods and services.
That should help stocks in a number of beaten-down industries, such as airlines, including Delta DAL, hotel companies such as Hyatt H, cruise line stocks including Carnival CCL, and gaming, such as Ceasars Entertainment CZR. The return to concerts and other public events should flow through to help drive profits higher at alcoholic beverage companies, such as Anheuser-Busch InBev BUD.
The slowing rate of economic growth, including the possibility of a recession, compounded by inflationary pressures, may constrict the overall level of consumer spending. But we don’t expect that these headwinds will derail the even larger trend for consumer spending to normalize, and shift back toward services and away from goods.
What Will Consumer Spending Normalization Look Like
The emergence of the pandemic led to one of the most rapid shifts in consumer spending behavior in history. Purchases of both goods and services initially fell off a cliff in April 2020, but spending on goods quickly recovered and soared higher.
The cumulative amount of growth on goods spending since January 2020 peaked in early 2021 and has slightly declined, but the emergence of several COVID-19 variants in the past year has slowed the normalization of consumer spending behavior.
We forecast that the current deviation in spending on goods and services will converge back to their prepandemic trends by mid-2023. This equates to a swing of about $450 billion, and this shift could even be larger. Many households may be saturated with goods across several categories in which consumers pulled forward future demand. In addition, consumers may seek to make up for services forgone during the pandemic.
Restaurants, hotels, recreation, and transportation account for about half of the current shortfall from the prepandemic trend. These areas represent only 20% of total services spending, but have been heavily affected by the shift in consumer spending behavior. Restaurant and hotel spending is down 4% compared with trend, yet built-up demand may be much higher than that given discretionary spending on goods remains well above trend. Recreation and transportation have the most ground to cover when it comes to returning to prepandemic trends
Healthcare spending is running about 6% below trend, but considering it comprises 25% of services spending it accounts for a significant percentage of the total services gap. Many consumers delayed healthcare services and elective procedures during the pandemic, but we expect that backlog will begin work its way through the system as more people feel more comfortable going back into healthcare settings.
A handful of other categories account for around two thirds of the remaining shortfall despite amounting to only 14% of prepandemic services spending. For example, trips and large gatherings have a long way to go to return to normal, as shown in the air and ground transport, amusement park, and live entertainment categories. We expect these to rebound in a similar fashion to the restaurant industry. Part of the lag in recovery for these categories is because large events often require planning far in advance, suggesting a lagged response compared with dining out.
Where to Invest to Leverage Off This Normalization?
As spending shifts back to services, one of the areas that we think is best poised to benefit is the travel and entertainment industry. This sector includes air travel, cruise lines, gaming, hotels, and ride-hailing, and is supported by technology providers dedicated to the travel sector. In addition, there are other areas that we think will benefit from employees going back to work and consumers returning to public events.
Leisure air travel has largely rebounded, but both business and international travel have lagged the overall recovery. While videoconferencing has become more commonplace, we project that business and international travel will return to prepandemic levels by 2024. While the stocks of all the airlines are currently undervalued, we think that Delta is best leveraged to benefit from the return of the business traveler and forecast that its operating margin will rebound to prepandemic levels in 2025.
Early on during the pandemic few industries were as tarnished as the cruise lines. They initially canceled departures and shut down travel routes. In 2022, industry capacity has returned, and utilization has been quickly rebounding. For example, during its first-quarter earnings call, Norwegian Cruise Line NCLH reported its number of bookings improves throughout the rest of this year with the fourth quarter in line with the comparable 2019 period, and at meaningfully higher prices. Booking trends for 2023 continued to be positive with both booked position and pricing higher and at record levels compared with 2019.
Similarly, we think other undervalued cruise lines, such as Carnival and Royal Caribbean Cruises RCL, are poised to benefit from the same trends.
Las Vegas is quickly recovering to prepandemic levels, and we think casino operators such as Caesars Entertainment and MGM Resorts MGM will benefit. With over 60 million members in its industry loyalty program, leadership in digital and sports gaming, and additional synergies to be derived from its merger with Eldorado in 2020, we think Caesars is the best positioned to benefit from the recovery in the gaming industry.
As vacations were postponed and business trips canceled in 2020, on average the amount of revenue per available room dropped more than 60% across the hotel industry. Revenue and occupancy levels began to rebound in 2021, and in 2022 we expect that many hotels will return to 90% of their prepandemic levels. Generally, we expect the hotels under our coverage to return to prepandemic levels in 2023.
Hotel stocks held up relatively well earlier this year but were caught up with the rest of the market in the June selloff. While many of these stocks are fairly to slightly undervalued, we see the most upside potential in a hotel REIT stock, Park Hotels & Resorts PK. It is the second-largest U.S. lodging REIT and is focused on the upper-upscale hotel segment. This stock is highly leveraged to the return of group, international, and business travel, and we forecast it will return to prepandemic levels in 2024.
Ride-hailing fell off a cliff early in the pandemic as people were unwilling to venture out into public and certainly did not want to be sharing space in a car with a stranger. As the pandemic subsides, both the number of riders and frequency per rider have been recovering. We think both Uber UBER and Lyft LYFT are well positioned to benefit, and both company’s stocks are trading at some of the most undervalued levels across our entire equity research coverage.
The travel technology sector is dominated by three players: Sabre SABR, Expedia EXPE, and Booking Holdings BKNG. While we view all three as significantly undervalued, Sabre is the one we think is the most leveraged to the return of the business traveler. In addition, Sabre has revitalized its technology platform, which we project will help it drive greater innovation and higher margins.
Return to Office
Workers are grudgingly returning to the office. According to Kastle Systems, a provider of office security solutions, its 10-city average occupancy index rose to above 44% in mid-June, near its highest level since the beginning of the pandemic. However, occupancy levels have moderated to 39.6% as of July 6, as the Fourth of July holiday and summer vacations took their toll.
As employees return to the office, if they're like most workers, they will also require coffee. With a loyalty program consisting of over 26 million users active over the past 90 days, we think Starbucks SBUX is undervalued. Loyalty program members represent over half of domestic sales, drive habitual purchases, and spend 2 to 3 times more than before joining the program. Starbucks’ stock has been under pressure as investors are concerned about the potential impacts from unionization drives. According to our sensitivity analysis, we think the market is being overly pessimistic about how much extra compensation expense from unionization would reduce intrinsic valuation.
Return to Public Events
In addition to returning to restaurants and taverns, consumers are becoming more comfortable going to public events, including sports and concerts. As more people attend these events, we think it could be a positive catalyst for alcoholic beverage manufacturers.
During the pandemic, alcoholic beverage consumption shifted from public places to the home, where consumers often traded down to lower-margin brands. When consuming in public, consumers tend to choose higher-end brands, which in turn should drive higher margins. We think this shift to higher-margin brands could be a catalyst to reinvigorate investor interest in alcoholic manufacturers such as Anheuser-Busch InBev, Boston Beer SAM, Constellation Brands STZ, and Molson Coors TAP, each of which is trading at significant margins of safety from our intrinsic valuations.
Morningstar Ratings indicate our view of a stock as under- or overvalued. 5-star stocks are undervalued, 3-stars stocks are fairly valued, and 1-star stocks are overvalued.
Which Goods Categories Benefited the Most?
Among the goods categories that surged during the pandemic, electronics and recreation remain in the lead when it comes to outperformance versus trend. In the electronics category, we would not be surprised to see consumer exhaustion. At this point, the need for work-from-home equipment has likely been filled and consumers have already traded up to the newest cellphone models.
However, we expect that recreational goods will continue to experience strong tailwinds, especially those in the powersports categories. Many consumers continue to prefer outdoor activities, and the impact of the pandemic had helped to expand demand for powersports outside of its historical core markets and end users.
There is a large backlog of demand in this space that remains to be filled as dealer inventory levels have been sold down, and over the longer term the targeted demographic group is expanding. Two undervalued companies that we think stand to benefit from these trends are Polaris PII, which manufactures off-road vehicles, and Malibu Boats MBUU, which manufactures recreational boats.
The pandemic rapidly led to major changes in individual and societal behaviors and the reverberations are still being felt today. While some behaviors may have permanently changed, we expect spending habits and patterns to revert toward historical norms. As these behaviors normalize, we see numerous opportunities in today’s market. For many of those companies that will benefit most, we see a significant number of them as undervalued and trading below their intrinsic value.