Clear Indexes Ideas

Shopping for Profits in the Retail Aisle

The Summer is flying by and excitement is building as we diligently work on setting up the fall 2008 portfolio and ETF design contest (students/professors/administrators: there is still time to get your school involved, email me). Of course, I’m not the only one excited for the upcoming school year—retailers are reading their cash registers. Bath & Beyond (BBBY)’s most recent 10-Q notes “sales levels are generally higher in August, November, and December.” August was primetime in the $65.7 billion (2007) back-to-school shopping market. But given the economy and the drop of household wealth between the stock market pull back and the decrease in home values, how much will parents open their wallets this year?

According to a survey conducted for the National Retail Foundation (NRF), the average American family with children will open their wallets wider this year and spend $594.44 on back-to-school shopping—a 5.4% increase compared to last year! Amidst a slowing economy and $4 per gallon gasoline, is such a gain feasible or is it wishful thinking on the part of an organization that encourages rising spending? A contrasting survey by Deloitte & Touche (http://www.deloitte.com/dtt/press_release/0,1014,sid%253D2281%2526cid%253D217302,00.html) found that 71% of parents plan on spending less on back-to-school shopping than last year. With imprecise forecasts such as these, it is important to apply common sense. Yes, spiraling energy costs and household net worth will change shopping habits. But school supplies, basic clothing, and certain electronics remain necessities.

It’s more likely that consumers will change where they buy than what. The retailers and producers that are most affordable should benefit the most from the changing distribution landscape of consumer spending. Discount retailers like Staples, Inc. (SPLS) and Wal-Mart (WMT) should fare well as shopper seek the basics at a discount. While there, a wondering eye make create additional purchase opportunities, adding to the “must haves list.” This is where Wal-Mart has an advantage.

Investors have embraced the stock—it is trading near a 52 week high. In Q1 of 2008, international sales increased by 22%. It has ridden the globalization wave from 1991, when the company opened its first international outpost in Mexico City, to Wal-Mart International making up 25.4% of its most recent posted revenue. The division has been able to profit from inroads made in Brazil, China, and India—and a presence in Russia could be imminent. It is in the unique position of being able to capitalize on growing wealth—and consumption--in emerging markets while at the same time becoming increasingly attractive to American shoppers looking for a bargain.

Mr. Corn is CEO of Clear Indexes LLC. He holds no positions in the stocks mentioned.

Another Reason A Recession Will Be Avoided

We can start this post with my being sick of the MSM begging for a recession. Why they are looking for any excuse aside from the deficit, the price of oil, the occupation if Iraq,  the falling greenback to the credit crisis.

Am I missing any other major issues? OK, so these are huge issues and ones that cannot be ignored. What also cannot be ignored is real wealth in this country and that consumers are not afraid to spend.

Last week I posted on gift cards, the retail stealth bullet, more on that later.

“The consumer is dead, long live the consumer.” This was the title of a post of mine last year so I could not very well use it again, could I? Well I used it the previous year in a note to clients, so I already had. The reason; at least one glass on the big Thanksgiving Day dining room table known as the US economy is more than half full.

Some products are sold, and others are bought. The key for manufactures and retailers is to create and then stock the items that are bought (predominately during holiday season) and then create an environment for the items that need to be sold.

There has been a lot of press about consumers cutting back. Much of this is about harder to get mortgages and falling home values. The press wants us to believe that too many consumers have mortgaged and re-mortgaged their homes, taking out loads of cash and have already spent it. There are many consumers, many who are in solid income brackets who refinanced their home and reduced their monthly payment while interest rates have been lower. This frees up cash.

Call me an optimist, but I do not feel there are too few people making good and responsible decisions. Lowering mortgage payments provides more available and discretionary cash without using their home as a piggy bank.

Bolstering this thought process, according to a report by The Conference Board last week, about 73 million US  households now have discretionary income, up from about 57 million in 2002. Total discretionary income in the US rose topping $1.7 trillion in 2006, with the household average at $24,335.

Defined for the study, households with discretionary income are those whose spendable income exceeds that held by households with similar demographic features. The proportion of  our domestic population with discretionary income has increased to nearly 64%, up from 52% in 2002 when the market  began its accent.

Nearly 78% of all discretionary income is held by households earning more than $100,000. Average discretionary income for this segment, $66,451, is 2.7 times the national average.

                                                       

DISCRETIONARY  INCOME HOUSEHOLDS
Total Households with Discretionary Income
2002	52.1%
2006	63.5%
Discretionary   Income (current dollars)
2002	$1,233.4 Billion
2006	$1,768.7 Billion
Average   Discretionary Income (current dollars)
2002	$21,657
2006	$24,335
Households With   Discretionary Income (by HH income)
$200k and   over	37.9%
$150-200k	16.1%
$100-150k	23.7%
$50-100k	19.4%
Under $50k	2.9%
Source: The Conference Board 11/07

So the well off and rich have more to spend making investments like Claymore/Robb Report Global Luxury Index ETF (ROB) appealing. It also provides the source to where holiday retail sales seem to be going, which according to MarketWatch is materially better compared to last year. The last three years have been record breakers, even if only posting small incremental increases. This year seems to smell more like a blow out despite all the woes around the world.

MarketWatch quotes ShopperTrak RCT Corp showing an estimates 8.3% sales increase and EBay Inc. (EBAY) also reporting a strong start.

Analysts predicting gloom and doom had also predicted a slowing of online sales and they will come to work tomorrow sadly disappointed. According to comScore Inc. Internet sales over Thanksgiving are up 29% to $272 million from last year. Friday’s web sales amounted to $531 million, a 22% gain over 2006 (data also from MarketWatch).

Resilient consumer numbers according to economists would have cut spending a mere 1-3%. The data shows a marked increase demonstrating, along with where the cash is sourced that the consumer is alive and well and living not just at the mall, at department and specialty store and at home online.

The numbers we are not hearing about are gift cards. These little buggers bring in cash but are not counted as revenue until they are redeemed.Since the National Retail Federation anticipates gift card sales to increase this season to $26.3 billion this season, retailers and the manufactures that supply them may have a jolly season. There will be winners and losers among retail firms and the manufactures who supply them.

For investors, this may be the good news that may lead the market higher by year end.

Disclosure: Mr. Corn hold no position in EBAY and his firm, Clear Indexes LLC is an adviser to Curtco Media the publisher of the Robb Report Global Luxury Index and he owns shares of (ROB).

Gift Cards are Changing the Score

Each year, as our country becomes more gift-giving challenged, the big retail product winner is now the “generically yours” Gift Card. Many of us were brought up being taught “it is the thought that counts” and then had the rude awakening as adults, learning to “get a gift receipt.” Today some people are lazy, others are fearful of buying the wrong thing for people after having been disappointed and had to supply too many gift receipts. Gift Cards are easily purchased from general merchandisers such as Macy’s (M), Sears (SHLD) and Walmart (WMT) to specialty stores ranging from Starbucks (SBUX) to Ralph Lauren (RL). Anyway you look at this phenomena, the National Retail Federation anticipates gift card sales to increase this season to $26.3 billion, up from $24.8 billion last year. Last year many gift cards were never redeemed adding to the bottom line of retailers but not the top line as revenue is not recognized until merchandise walks out of the store.

This time in 2006 I posted:

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Last year a lot of holiday shopping occurred as the; buy yourself what ever you want on me program, also known as gift cards. Last holiday shopping season, November 2005 and then in January 2006 I had commented for Bloomberg TV and radio about the tremendous impact of gift cards. Essentially, stores take in the cash for a gift card but most stores do not account the transaction as revenue until merchandise has been exchanged for the card. Not unlike the old travelers checks game, some cards are lost, tossed into the back of dressers and never used. There is quite the profit margin on those, yet they are not ever booked as revenue. Additionally, stores have the use of the cash, sometimes for months. Most cards are redeemed by February and redemptions slowly fade out until June. After June they are assumed to not be redeemed.  

This is an accounting and revenue recognition issue. It shows up in operating margins and other places that quants like us like to dig. The issue is the numbers are skewed. Gift cards are bigger and bigger numbers each year, over $18 billion in the 2005 holiday season.  

We are waiting to see how the big four accounting firms jigger the books. Of course, some of us will be watching very closely.

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Today, the availability of gift card malls and other expanded uses are making gift cards even more popular and versatile. Comdata Stored Value Solutions recently conducted its fifth annual survey of gift card purchases by adults providing insights into the upcoming holiday retail season.

• For the 2007 season the average gift card purchaser expects to spend $203 on holiday gift cards, up from $186 in 2006.
• The average amount per card increased from $46 in 2006 to $53 in 2007.
• 38% of those surveyed who have never purchased a gift card are very or somewhat likely to purchase gifts cards this holiday season, representing an 81% increase in new card users over last year.
• 53% of card users often or always spend more than the amount originally loaded onto their cards. They are also most likely to redeem their cards over two visits, increasing store traffic and the potential for sales over the value of the card.
• One in five says they pay retailers to reload their cards. On average, they reload cards with $47, up from $32 in 2006.
• 85% purchase gift cards because they want the recipient to be able to select their own gift, while 57% don't know what to buy.
• Department stores are still the most popular place to purchase a card, followed by clothing and book stores, then restaurants.
• One-half of gift card purchasers are more likely to buy a gift card that comes in a box, with ribbon and tissue, or in a tin.

The survey shows that the convenience of gift card malls is clearly a selling point for “lazy” or “I can’t figure out what to buy you” consumers.

• Last year, 94% of purchasers bought cards at a specific retail location. In 2007, only 88% prefer a specific location.
• Last year, 22% made purchases from gift card malls, and this year, that number increases to 27%.

The market for children's gift cards is also growing.

• Approximately one-third of all gift cards purchased last year were purchased for children or teens.
• 4% of cards purchased were for children under the age of five.
• Of those who have purchased gift cards for children, 35% are the child's parents, followed by 30% who are aunts or uncles.

Hispanics are the demographic utilizing the most Gift Cards

• Hispanics received gift cards with the highest average value among all ethnic groups; $71 representing a $33 increase from last year
• Hispanics (69%) are most likely to spend more than the value on their cards, making up the difference with their own money
• 26% of Hispanic report giving gift cards to children as a budgeting tool   

Stores, despite the delay in revenue are going to great lengths to drive gift card sales. Customization is the latest trend for branding and differentiation. Here are a few examples:

• Macys.com, upload your own photo onto a gift card and include a personalized greeting card for a mere $5 above the value of the card
• Bestbuy.com (BBY) offers personalized picture gift cards, for $4.50
• Starbucks.com has introduced design-your-own gift cards, along with a $4 customization fee
• For no additional fee Home Depot (HD) a card that doubles as a how-to do-it-yourselfer DVD or one that can be redeemed for a free 20-ounce Coke product
• American Eagle (AEO) is selling recordable gift cards so you can record a message for the recipient
• McDonald's (MCD) has teamed with Upromise to offer the chance to earn college savings with every purchase or reload of a gift card

A Consumer Reports survey found the dark side of gift cards. As the travelers check industry has found, an unredeemed card has a beautiful equation. Payment for no service = near 100% profit. The rub for retailers it that they do not get to book any revenue and for quants like me that means scrutinizing efficiency statistics for answers as profitability at these firms will rise if the numbers get big. According to Consumer Reports, the numbers are headed in that very direction.

A National Retail Federation survey found nearly 90% of shoppers plan to buy two or more gift cards this holiday season.

The number falling straight to the bottom line is still to be determined but $8 billion (Consumer Reports) in gift cards went unredeemed last year, as nearly a third of survey respondents with unused gift cards simply forgot about them.

Some conclusions:

• Gift Cards are more than simply here to stay, they are growing swiftly
• Gift Cards delay revenue which could deflate holiday revenue numbers and smooth them out in January and February when most cards are redeemed
• Many shoppers will spend more than the face amount of their gift cards making them a real asset for stores and some shoppers will even add money to their cards.
• Many shoppers never redeem their cards, causing profit without revenue, making firms appear more efficient then their operations achieve
  

Watch more than revenue this holiday season. Ask management to report separately for gift card sales. Based on revenue alone, Black Friday and Cyber Monday may come later than anticipated, but the bottom line still may improve and sooner than analysts anticipate.

Disclosure: Mr. Corn holds no position in any of the securities mentioned.

Creatures of Habit

A key facet of uncovering if a theme is a coincidence or truly investable is by evaluating its sustainability and repeatability. When it comes to consumer products, there are numerous touch points that can create a long term relationship; product and consumer, company and consumer brand and consumer. These like many relationships are hard to break. The big ad agency BBDO recently published a study and Karl Greenberg at www.mediapost.com picked it up. I am excerpting some of it below.

It deems brands that are embedded in rituals "Fortress Brands" because once ensconced in peoples' ritual lives--brushing teeth, buying a beer, or shaving, for example--people are unlikely to remove them.

The study, which took nine months, involved ethnographic research in 26 countries, 2,500 hours of documented and filmed behavior, quantitative feedback from more than 5,000 people, and interviews with psychologists, nutritionists and sociologists. Despite the study's breadth, it found that people tend to adopt the same broadly defined rituals.

In fact, BBDO's study focused on five rituals performed most often by most people on Earth: "preparing for battle," which for most of us means girding our loins for work; which includes brushing teeth, taking a shower or bath, having something to eat/drink, talking to a family member/partner, checking e-mail, shaving, putting on makeup, watching TV/listening to radio, and reading a newspaper.

The study found that 89% of people resort to the same brands for these sequenced rituals, and three out of four people become disappointed/irritated when their sequence is disrupted or their brand of choice is not available.

One of the architects of the study, Lovatt says brands that succeed in becoming parts of people's ritualistic behavior are those that create product, positioning, packaging, advertising and promotions that address both the specific ritual and the underlying function behind it, if there is one.

Now we are far from long ad agency networks as I have witnessed first hand their inefficiencies and their being brought into the digital age kicking and screaming. Our focus goes back to product companies and the repeatable and sustainable sale. The consistent revenue derived from the brands that are embedded in our lives. If those products can be translated across boarders as the study suggests we are all more alike than different, and done profitably, those sales numbers will drop to their balance sheet. It the job of our multifactor models to rank companies based on their value or rate of growth. When we measure these fundamentals as being out of whack with its stock price, we buy. We can own a company for as long as they are necessary to our daily lives, or until the stock becomes overvalued or growing beyond a reasonable price.