Image Source: Mike Mozart
Walmart’s results were quite reassuring regarding the health of the economy. There are also pockets of significant strength, with prestige beauty being catapulted by a “selfie generation.”
By Brian Nelson, CFA
No Recession At Walmart
Following what can best be described as “carnage” across the retail sector when Macy’s reported August 14, Walmart (WMT) eased some of the concerns in the retail sector when the bellwether reported August 15. Although Amazon (AMZN) seems to get most of the attention when it comes to assessing the health of the consumer, Walmart remains twice as large, as measured by revenue. Walmart generated ~$514 billion in revenue during its last fiscal year, while Amazon hauled in ~$233 billion. If the consumer is struggling, it’s going to show up in Walmart’s results.
On August 15, Walmart posted fiscal second-quarter 2020 results (ends July 2019) that showed total revenue advancing 1.8%, and excluding currency, total revenue increased 2.9%. Second-quarter comparable sales at Walmart U.S. came in at 2.8%, while its U.S. e-commerce sales advanced 37%. By comparison, second-quarter revenue increased ~19.9% at Amazon, while sales at eBay (EBAY), adjusted for foreign-exchange currency movements, increased ~4%. Target’s (TGT) comparable digital sales grew 42% during the quarter ending in early May. Though Walmart and Target are playing catch up when it comes to digital sales, their growth rates aren’t too shabby by any stretch.
One of the key takeaways from Walmart’s report that may indicate the U.S. consumer is doing okay is that U.S. comps from the retailer came in at 7.3% on a two-year stacked basis (adding last year’s quarter comp percentage to this year’s quarter comp percentage), which the firm noted was “the strongest growth in more than 10 years.” Walmart also noted that “segment operating income increased 4%, marking the fifth consecutive quarter of growth.” If bears are looking for reasons to worry about a recession in the US, Walmart’s performance, released August 15, is not a place to look. Our favorite idea on the theme of discount retail remains Dollar General (DG), and we continue to let shares run.
We maintain our view that the department-store business model is “dead money,” something we’ve been saying for years as J.C. Penney (JCP) and Sears (SHLD) have struggled. Macy’s (M) and Kohl’s (KSS) are more-than-likely value traps and in the coming years, investors should expect dividend cuts, not dividend increases. Walmart is of a different theme, and the discount retailer raised its fiscal 2020 adjusted earnings per share guidance to the range of a “slight decrease and a slight increase” from a prior guidance calling for a low single-digit decline.
Estee Lauder Not Cheap
In other retail news, Estee Lauder (EL) is trading at about 33 times the high end of its fiscal 2020 adjusted earnings guidance ($5.90 and $5.98 per share), and we continue to scratch our heads over this market valuation. The retailer put up a great fiscal fourth-quarter report August 19, but its valuation is completely out of whack, in our view, not only reflected in a high forward earnings multiple, but also based on our fair value estimate. Fundamentally, things are looking great at Estee Lauder, with its fiscal 2019 results showing revenue increasing 12% on constant-currency basis and diluted earnings per share jumping 21% on a full-year basis. There are certainly pockets of strength in retail. Here’s what CEO Fabrizio Freda had to say:
Prestige beauty continues to be one of the most desirable consumer sectors. As the best diversified pure play in the industry, we are uniquely positioned to capture global share. In fiscal 2020, we plan to continue to invest in the most compelling opportunities, including those in emerging markets beyond China. We expect another year of strong net sales growth, margin improvement and a double-digit increase in earnings per share.
Estee Lauder’s press release couldn’t have read more positively. The company noted that nearly every market in the Asia/Pacific performed well, perhaps assuaging concerns about broad-based weakness as a result of the US-China trade/currency war. The consumer may be cutting back in some areas, as Tapestry’s (TPR) results recently showed, but they are not cutting back in prestige skin care, makeup, fragrance and hair care. For fiscal 2020 (ends June), Estee Lauder expects that global prestige beauty will grow at a 6%-7% annual pace, despite the protests in Hong Kong (EWH), anticipated Brexit in the U.K. (EWU), and continued weakness in brick-and-mortar in the U.S. Prestige beauty appears recession resistant.
Concluding Thoughts
We live in a so-called “selfie generation,” and Unilever (UN, UL), L’Oreal (LRLCF), Sally Beauty (SBH), and Ulta Beauty (ULTA) are key ways to play this theme. Given how fast fashion can change, we’re not going to jump into any “selfie-driven” ideas, however. The ultra-high end brands, including LVMH Moet Hennessy (LVMH) and Ferrari (RACE) should continue to do well, but Tapestry’s results probably don’t translate well to underlying performance at mid-tier aspiration brands, including Capri Holdings (CPRI). We continue to prefer the low-end of retail in this economic environment and where we are so late in the economic cycle. Dollar General remains our retail consideration for now.
Related: FPKT, JD
Related ETFs: MILN, FXI, MCHI, XRT, RTH
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Brian Nelson does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.