The Best Retail Names

As Toby outlined the Q2 mastermind there is a very crowded trade in the works....AMZN vs every retail company. Mr. Market doesn’t know what to do with uncertainty and tends to extrapolate one year’s earnings (or one quarters earnings) into the future indefinitely. There is no doubt that there has been pressure on top line revenue and margins for most retail companies. I am sitting on the other side of the amazon trade saying "it’s not THAT bad".

What are the best names? I love to find whole cigars looking for cigar butts. Earlier this spring I had invested in KORS as it was cheap on the screeners and they were planning on buying back stock with excess cash flows. It has worked out great, although recently management haven’t been able to resist acquisition madness and are destroying value by overpaying. Why on earth would you pay 60x earnings for another company when your own company was less than 8x....this is beyond me. I wouldn’t recommend them anymore as they are seeking to become a Luxury Brand, and will likely overpay for more and more brands. The synergy of strong cash flows and buybacks (only if cheap) is simple and great for EPS.

FL looks good to me. I believe they will have some degree of resistance towards online retail....shoes and sportswear are some of those things you kind of have to try on and walk around in....maybe I am wrong. Cheap and cash flows point to some easy 15+%.

LB are another name that has some resilience imo. The need for a woman to feel sexy is a powerful and underrated moat. Again I think that product is one that is more likely to be purchased in person than online. They are a fairly popular brand, curious to see how cheap they will get. I find the more popular and wider the moat the higher they trade at like a LULU. Cash flows are quite good, and hopefully their historical ROIC can apply to their recent CAPEX.

TGT as outlined in @PrestonPysh article https://www.forbes.com/sites/prestonpysh/2017/08/19/targets-intrinsic-value/#6a9772777da7 I would also recommend. Typically I invest in low earnings multiple because it results in strong cash flows. TGT has those cash flows with an average earnings ratio. Best part of those strong cash flows is the share cannibalism! I consider TGT management actually quite good, they can get cash flows year in and year out. Selling their pharmacy to CVS and some space to Starbucks has been great. You have to get past their huge mistake trying to move into Canada though.

BBBY is cheap. I don’t particularly consider them wide moat. Their top line revenue hasn’t fallen yet, although their margins are under siege. Even if you price in margins further contracting, I have no doubt some 15+% is available....perhaps closer to 20+%.

http://acquirersmultiple.com/ Is full of retail names. Curious to see other TIPers view.

Best Regards,
Colby

Comments

  • edited August 31
    Here are the retail stocks i currently own. Most I bought in the last week:
    BBBY,FL,GCO,FRAN,FOSL,HIBB.

    After being mostly in cash,i really bought pretty heavily.

    My favourite?

    HIBB!!!!!!!

    I will also write an article in my blog about retail next week. Finally there is something interesting to invest:-)
  • One more comment:
    1) TGT looks not attractive to me at current prices (compared to other retail stocks). If it drops another 60-70%,i will have another look
    2)LB has a messed up balance sheet.also not attractive.

  • @christoph Your correct about LB! Its got a pretty nasty balance sheet, those sexy vixens on the investor relations page are quite distracting! Bad balance sheet instant disqualification for me, that was a hard lesson to learn.

    I'll have to look more closely at HIBB! Numbers look good at a glance....I hear kids sports teams use them exclusively for uniforms....although I have yet to go into one.
  • Hello @christoph

    What made you take a position in FOSL? I would like to know your thought process in your decision. It looks like the whole smartwatch trend is killing their traditional watch business.
  • Hi all,

    sorry for replying so late. I have written my latest blog entry in www.christophwolfvalueinvesting.com about this latest question. And also about retail stocks in general.

    thanks

    Christoph
  • Great article Christoph!!

    I have been following the stocks ever since you mentioned them. However I am having trouble to execute, I am still looking at the lowest price that the stocks have been and I want to snatch them up around that price. However, Genesco and HIBB for example already increased 20% since I could have bought them. Now I feel stupid lol.

    I was wondering how do you manage to buy at a time that feels good for you? Since timing is not possible, I just have a feeling I should wait a bit and snatch them up for less.

    Kind regards,

    Tim
  • edited October 8
    @Tim,

    I can't speak for Christoph but I'll offer you my thoughts for what they are worth.

    First off, don't feel stupid. As Warren Buffett has said, an error of ommision is far better than an error of commision, in other words its better to miss out on buying a good stock than to make the mistake of buying a bad stock. You may miss out on some capital gains but you didn't lose any of your principal. Another thing Buffett says is, In investing you don't need to swing at every pitch, there are always more investment opportnities around the corner so don't become to attached to any one stock.

    Now to your question, Thanks to the value investing framework we don't need to buy a stock when it 'feels' good for us, feelings don't come into it.

    We simply determine the intrinsic value of a given stock, add in a suitable margin of safety and only buy when the price is below that range of value. If the stock goes down after we have bought it, we can buy more to lower our average cost price providing the fundementals have not changed. If the stock is above our determined entry point we simply wait for the market to offer it to us at the price we want or we move on to the next company. A simple way to avoid becoming emotionally involved in the buying process is to place a limit order, this basically gives an instruction to your broker to buy a given stock if it falls below your desired entry point, you can normally set these up to a 90 day period. If the limit order expires and the stock price didn't fall to your strike price you only end up paying a small fee, if your strike price is met you get the stock you wanted at the price you determined as reasonable.

    The final thing I'll say is don't worry about trying to get rich quick, if you follow the value investing approach and are willing to keep learning you will do well over time.

    If you have any questions please don't hesitate to ask, we are all here to help each other become better investors!

    Regards,

    David
  • @christoph,

    I greatly enjoyed reading your article on retail. Here are a few thoughts I had.

    With regards to Toys R Us, I think there problems were mainly the result of a leveraged buyout that took place a few years ago. The balance sheet was drained of cash and the company's debt level ballooned leading to liquidity and debt servicing issues.

    You point regarding high end retail is an excellent one and reminded me of something I read in Robert Cialdini's book 'Influence; The Psychology of Persuation'. (If you haven't read this book I emplore you to read it!)

    https://www.amazon.com/Influence-Psychology-Persuasion-Robert-Cialdini/dp/006124189X/ref=sr_1_1?ie=UTF8&qid=1507448423&sr=8-1&keywords=influence+the+psychology+of+persuasion



    He relates the story of a company, a jewellery company if memeory serves me correctly. There successful marketing campaign centered around creating a perception of exclusivity and prestige with their products. This prompted consumers to pay a premium for their products as they desired to associate themselves with these ideas.

    I agree that those retail companies that deal in commodified products will likely suffer, the lowest-cost producers are the only ones which might stand a chance but Amazon's economies/efficiencies of scale will continue to squeeze their margins.

    We should focus attention on those companies which possess what Buffett calls "franchise value". He discusses the difference between two types of enterprise, a standard business and an economic franchise in his 1991 Shareholders Letter;

    "An economic franchise arises from a product or service that: (1) is needed or desired; (2) is thought by its customers to have no close substitute and; (3) is not subject to price regulation. The existence of all three conditions will be demonstrated by a company's ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital. Moreover, franchises can tolerate mis-management. Inept managers may diminish a franchise's profitability, but they cannot inflict mortal damage.

    In contrast, "a business" earns exceptional profits only if it is the low-cost operator or if supply of its product or service is tight. Tightness in supply usually does not last long. With superior management, a company may maintain its status as a low-cost operator for a much longer time, but even then unceasingly faces the possibility of competitive attack. And a business, unlike a franchise, can be killed by poor management."

    http://www.berkshirehathaway.com/letters/1991.html

    Regards,

    David
  • @christoph .

    Again great article and I totally agree, so I am currently having limit orders on FL, HIBB, FRAN, BBBY, FOSL and GCO.


    @David ,

    Thanks for your reply! I totally agree with your strategy and I have set up limit orders indeed!
    I think I just need to mentally train myself more into becoming a better Intelligent investor.

    With regard to the margin of safety, I am wondering what kind of margin of safety you would use for example a FL, HIBB or GCO?

    I now use two methods and I was wonder how you price in the margin of safety, the way I see it you have two options:
    Lets use HIBB as an example.

    1. Growth rate last 9 years is 8,2% first 10 years, 3 % after 10 years, average FCF = 40,7, discount rate 10%.
    The intrinsic value would be around 37,9.
    Current price is 14.45 so I would say good margin of safety. Price to book =0.9.

    2. Growth rate 0% first 10 years, 0% after this, Average FCF 40,7, discount rate 10%
    This gives intrinsic value of 17.86.
    Current price is 14.45 so also decent margin of safety since 0% growth is used. Price to book =0.9.


    Now I have difficulty in answering what is a good margin of safety? I know warren Buffett likes to buy a dollar for 50 cents, so half the price of Intrinsic value would be good?

    I am wondering what is your thought process with respect to determining the margin of safety.

    I agree with you on the not getting rich quickly and that you don't have to swing every time. I am a very conservative investor since as a student I have limited funds at the moment and I would like to protect my principal.

    I have just finished reading 'the snowball' about the life of Warren and I am looking for a new great book on investing. Do you have any suggestions? I have read the intelligent investor and am still reading security analysis (bit dry book though).

    Thanks for your reply again!

    Kind regards,
    Tim
  • @Timrubenjamin,

    With regards to determining MOS there are a few things to consider.

    1. How confident are you about your investment thesis and estimation of intrinsic value?, if you are looking at a wide moat company with very stable margins and cashflows which is selling cheap simply because a bear market is in full force then a 20% MOS may be appropriate. Conversely, if you are looking at an average company or a turn-around which is selling below intrinsic value you may demand a 40-50% MOS
    2. What are the other risks involved. Say you decide to invest in some Russian companies, you would demand a greater MOS than that which you would put on a comparable American company since there are other risks involved, i.e. Government meddling, weaker accounting standards, higher chance of fraud, political instability etc
    3. What kind of return are you looking for?. The defensive investor will accept a lower rate of return whilst the enterprising investor may tolerate a marginally higher risk for a greater rate of return.

    In summary, there is no fixed rule for applying a MOS and each company must be judged on it's own merits and risks.


    With regards to books I recommend.

    'One up on wall street' and 'Beating the street' by Peter Lynch are excellent and easy to read. Joel Greenblatt's 'The little book that beats the market' and 'You can be a stock market genius' are also easy going and full of useful information.

    If you are looking for a book with lots of data and formulas I recommend a book called 'Excess returns: A comparative study of the methods of the world's greatest investors'. Put simply, I love this book! I refer to it several times a week and it is a constant source of ideas, insights and wisdom.

    Roger Hagstrom's books on Buffett are great and 'The Intelligent Investor' by Ben Graham is wonderful but possibly a bit on the dry side for you.

    Regards,

    David
  • @David ,

    Thanks for your advice and I am going to look for the books you recommended!
    Return: I am looking for 10-15%+ but maybe this is too enthousiastic but I am young enough to learn the traits of an intelligent investor haha.

    Thanks again,

    Kind regards,
    Tim

    p.s.
    Bought BBBY today, let's see what the future holds
  • @christoph well put! I put your valuations right on point.....babies thrown out with the bathwater.

    So I have always thought that the story impacts market cap greater than the event itself. For example company XYZ files an 8-K stating there will be a 100M loss on next quarters earnings. The resulting change in market capitalization will be far greater than the 100M. No manager wants to take the (100M) decrease in earnings pinprick so 1B+ falls off the capitalization....or a combination of explanations, maybe manager doesn't want the new uncertainty. The baby does get thrown out with the bathwater end result.

    I am limiting my retail exposure to 15% aum with 5% positions in BBBY, HIBB and FL. I am skeptical amazon will bankrupt these businesses next 5 years.....also known as amazapocalyse. Even with some fairly pessimistic (revenue growth) companies like HIBB have some bookoo cash flows. Am I happy sitting on the return on cash flow from continuing operations? absolutely. The hard part is waiting and determining if permanent earnings power has been impaired. Even so, strong balance sheet buys time and eases the mind from the bear case.
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