April 10, 2017    4 minute read

A Retail Reversal

The Long and the Short of It    April 10, 2017    4 minute read

A Retail Reversal

There are two types of trends: cyclical and secular. Cyclical refers to short-term cycles that tend to reverse over time. Secular on the other hand, do not tend to reverse as quickly, if at all. Secular stagnation, a term coined by Alvin Hansen to describe slow growth for a protracted period of time, is a longer theme that stays deep rooted in society unless something fundamental comes along to change it. Low-interest rates are a secular theme from amongst other things, a global savings glut. The transition to cloud-based forms of storage, as opposed to memory sticks, is another secular trend and will only continue.

The focus of this piece will be the clothing stores on the high street and the headwinds blowing strongly on the sector, with some final comments on how an investor could profit from such changes.

The Luxury Segment

The retail arena has some secular forces, which are interrupting business models that will fundamentally change the game. In the US, thousands of stores are closing (see chart below) because the trend is towards the internet. Those firms with hard assets, soon to be liabilities, will have to reconfigure their models to be more online based. Take ASOS for instance, who don’t have a high street store.

They do not need to spend millions of dollars on rent in expensive city street locations. Brands like Chanel, Louis Vuitton, etc. spend thousands on rent to display their products on Bond Street, yet the majority of business is now conducted online.

The share prices are reflecting that. Ralph Lauren is closing its flagship store in Manhattan and seeking to implement a big restructure in company strategy. Its share price is down significantly after announcing closure plans.

The High Street and Online Players

Meanwhile, ASOS is already expanding in a big way to the US and Europe, via its massive Eurohub 2 warehouse. Although for the present, sales are mainly originating from UK consumers, having such a rapid growth plan for the EU and the US will allow sales to rocket and margins to rise. EU sales were up 48% year on year, and although margins were broadly flat, this was due to an increase in capital expenditures.

In terms of automation, which is an important aspect for distribution, management expects the new Eurohub to be fully automated over the next 12 months. This will likely be great for sales and growth, especially as sales growth in Europe continues.

The main takeaway from all this is that ASOS is a firm that is booming. Another online retailer, Boohoo, filed for an IPO a few years back. Its stock price has gone up exponentially and is climbing daily.

Meanwhile, the traditional retailers like Next and M&S have not performed nearly as well on a relative basis and will likely not be able to expand their sales materially over the coming quarters. The trend is already underway for store closures while the online trend is gathering speed.

How to Monetise the Trends

So how can an investor profit from all this? The obvious option would be to buy ASOS or Boohoo stock. However, if the market goes down because President Trump bans another race from entering the US, ASOS shares will take a tumble. A good way to play this theme would be to do a spread trade i.e. Long ASOS/Short Next.

In this strategy, if the market as whole goes down, the investor would be mostly unaffected because the profitable short position in Next would offset the decline in ASOS. To make money, the spread would have to rise as ASOS outperforms Next on a relative basis, while only bearing company risk. The chart below shows the spread between ASOS and Next. Given the secular dynamics at play, this spread should track higher over the coming quarters. Boohoo and M&S show similar results.

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