Corporate credit: Key themes in retail heading into earnings season
admin | April 12, 2019
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
While the first quarter of any year is not necessarily the most important for a retailer’s top line revenue and other cash flows, it has become an important quarter for investors looking for full-year guidance. It gives investors a peak into the items management teams will need to focus on or overcome to hit the guidance they set at year-end. Some of the 2019 key themes likely to echo in the earnings season ahead: top line, margins and costs as growth slows and competition picks up.
Coming off a relatively solid year and difficult comparisons, growth is likely to slow a bit in 2019 with the overall economy. Competition from Amazon (AMZN) continues to remain a threat to both the top line and margins. However, a couple of credits have proven that they not only can compete with AMZN, but thrive. Home Depot (HD), posted record results in 2018 and while we expect sales growth to abate a bit in 2019, we still expect it to be solid (above 4.0%). HD has separated itself from its closest competitor (Lowe’s Companies Inc.- LOW) with investments in product assortment and customer service. Furthermore, additional investments in infrastructure technology and supply chain should further separate HD from its peers. Omnichannel efforts such has buy online and pick up in store helps to drive traffic. We view HD as a core hold in the retail sector.
BBY posted some of the strongest SSS growth in the retail space for 2018. Management’s ability to see trends early and adjust business lines accordingly, has helped the credit to grow the top line without losing margin. BBY’s focus on service lines (Geek Squad and GreatCall) is a solid defensive play and is likely to continue to support growth. Furthermore, price matching and its lease-to-own program is helping to build a loyal customer base. While BBY spreads have come in considerably since the beginning of the year (roughly 100bps), spreads could continue to tighten based on good growth and management’s very conservative balance sheet.
Apparel – Department Stores
While JWN, KSS and M were all able to post SSS growth in 2018, only KSS was able to grow margins as well. KSS’ focus on partnerships, particularly with AMZN, helped drive traffic. Furthermore, KSS’ adoption of small stores has helped productivity and margins. Both traffic and store rationalization will continue to remain a theme in 2019. We think the expansion of private label could be a theme in an effort to drive traffic. Management teams will also need to decide how much square footage is necessary as stores now act as mini warehouses for online fulfillment.
Both KSS and M actively reduced debt in 2018. While KSS is likely done with debt reduction, M noted that they will likely continue to reduce debt in 2019. We view any further debt reduction by M, or the potential for the company to extend the tenor of its revolver as a catalyst for spreads of its 2023 bonds to collapse closer to KSS.
Rising wages and freight costs were a major theme for mass merchants, grocers and dollar stores in 2018. In an effort to offset increasing wages, many are looking to invest in technology with respect to inbound freight and inventory levels to help reduce employee hours. Investment in services such as curb side pick-up and same day delivery are themes likely to be echoed in 2019. We expect margins to remain pressured in 2019 due to further investments in price. Lastly, private label expansion is a key differentiator for mass merchants. TGT’s continued investment in private label could support both sales and margin growth.
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