Image Source: DonkeyHotey
By Kris Rosemann
The 2016 election cycle has been one characterized by unprecedented amounts of criticism and accusations, of both the personal and political variety, and it may be true that the perceived political environment from the view of the general public has not been in such a state of uncertainty for some time. Let’s not get into the details of who called whom what in last night’s Presidential debate, but some parents were reportedly not allowing their children to watch the debate out of fear that their values or outlook on democracy could be skewed.
But could the uncertainty surrounding the election actually be enough to impact consumer activity at retail outlets and restaurants? Some are beginning to believe so. Yum! Brands (YUM) CEO Greg Creed was the most recent executive to pin weakness in the industry on the general uncertainty surrounding the election. From the firm’s fiscal third quarter conference call (October 6):
I think there’s just great uncertainty as to what’s going to happen in the U.S., in particular, as a result of the outcome of the election. It goes without saying that people are sort of trying to decide who to choose and what the impact will be on the economy. And I think people maybe just hunkering down a little bit. …. And I think once we get through the election and then that uncertainty is removed, hopefully, the market will find some momentum.
Throughout the months of August and September, other executives have shared similar thoughts regarding the current political and retail environments, ranging from the executive teams of other fast food restaurants such as Wendy’s (WEN) and Popeyes Louisiana Kitchen (PLKI) to traditional retailers including the likes of Gap (GPS) and Calares (CAL) to specialty retailers like jeweler Signet (SIG). McDonald’s (MCD) had even warned about the implications of the election on its performance in July when the respective party conventions were generating headlines. We recently explored more tangible factors in the restaurant space, “Restaurant Traffic – What’s Going On?”
While retailers are almost certainly correct in saying that the election has some consumers second guessing the shape the country is in, are they correct in their assessment that this is enough to impact spending habits? It is no secret that US Presidential elections create uncertainty in corporate board rooms across the US where massive investment decisions are made, but has such uncertainty really trickled down to American dining and living rooms as well?
We think it is a much more reasonable leap to make that management teams will take a wait-and-see approach to the election, as the differing policies of candidates could have an impact on their businesses’ operations and investment decision, than it is to conclude that average consumers will put off buying new clothes or restocking the refrigerator. Are these retailers and restaurants suggesting that a large portion of Americans have turned into some mild form of doomsday preppers, hiding their assets in sock drawers while stockpiling cans of beans?
The appeal behind being able to blame the election cycle for these businesses is evident: it is a transient issue largely out of control of management. Taking uncertainty and spinning it into an issue that is expected to pass in the coming months is a minor victory in terms of damage control for executive teams as such an explanation temporarily takes the place of the major long-term threat to traditional retailers and restaurants: e-commerce (yes, even at restaurants).
As we continue, it is worth noting that consumer confidence in the US rose to a nine-year high in late September, according to a report from Conference Board. In addition to the counterargument being presented by rising consumer confidence despite the ‘uncertainty,’ the election does not appear to be impacting the sales of e-commerce giant Amazon (AMZN). Nevertheless, a disappointing 49% of US chains increased same store sales in the second quarter of 2016. While some retailers and restaurateurs continue to look around for something to pin their woes on, others are taking action. E-commerce was the focal point of retail giant Walmart’s (WMT) recent investor meeting, and CEO Doug McMillan stated that the firm is going to continue to evolve into what looks more like an e-commerce company over time. Its investments in JD.com (JD) and Jet.com speak to this.
We are witnessing the genesis of the virtual restaurant market, particularly in New York City, which is being tabbed by some as the savior of the restaurant business. The concept is the same as any e-commerce business: consumers order online and the product is delivered. The idea of food delivery is clearly not a new one, but these virtual restaurants are new in the sense that they have no dining space or customer facing portion of their businesses. They instead are focused on using technology and data points to improve the desirability of their dishes to the consumers while lowering rent costs and reducing the amount of labor needed. The cost to fail is materially reduced from a standard restaurant, making experimentation, and ultimately innovation, an innate characteristic of the market.
Whether such a trend succeeds in mainstream marketplaces outside of New York City remains to be seen, but we view the development as a nod to the secular trend that continues to weigh on traditional brick-and-mortar retailers and restaurants. We see the continued shift in consumer preferences toward in-home shopping as a much more likely candidate for sales pressure than uncertainty surrounding the election. Competition among online retailers will only make the online shopping experience more attractive to consumers, as well as make e-commerce firms stronger operators as the industry evolves.
As an example of the growing popularity and demand for online shopping, let’s consider an Amazon Prime membership, which currently costs $99 per year. With that membership, consumers receive access to Amazon’s library of TV shows and movies–already a better value proposition than competitor Netflix (NFLX) when ignoring content preferences–as well as music, e-books, and free two-day shipping on any product purchased through Amazon. Ease of ordering technology continues to advance, and some products can be ordered with a literal push of a button. How will traditional retailers compete? Those leaning into the wind are more likely to ultimately remain standing, in our opinion.
Newsletter portfolios holdings Michael Kors (KORS) and Coach (COH) are both working to reduce their reliance on traditional department stores as mall traffic wanes and they attempt to avoid brand-damaging discounting from retailers, “Brand Image Taking Center Stage in Aspirational Goods.” Coach expects to close ~250 of its wholesale locations while issuing a reduction in markdown allowances, while Michael Kors continues to see progress in expanding the footprint of its digital stores in North America.
We’re not ruling out the potential for the election to be one of the factors driving down consumer spending for traditional brick-and-mortar retailers. In any case, however, we don’t see a pressing need to adjust our exposure in either newsletter portfolio, though we continue to monitor the dynamics of the broader retail environment. Our favorite long-term picks in the restaurant sector remain Buffalo Wild Wings (BWLD) and Cracker Barrel (CBRL), while we are avoiding direct exposure to any traditional brick-and-mortar retailer.