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COVID-19 theme: Small players and weak players will get crushed and big players will expand. This is not the decade long story this is the current story. Your favorite mom-n-pop retailer is getting crushed and we're going to suffer through a dumbed-down Walmart existence for a while but new businesses will pop up with great new ideas over the next few years.
Retailing Is a Jungle That Will Keep Favoring Giants. Mom and Pop, Look Out.
Retail traffic fell almost 92% last week, compared with the level the year before. In normal times, that would be a disaster. In the time of coronavirus, it’s an improvement from the nearly 98% year-over-year decline that U.S. retailers suffered for most of April. Yet much like the virus itself, the impact of Covid-19 hasn’t been evenly felt among the nation’s retailers. The biggest and strongest aren’t just surviving, but thriving, while many smaller store chains and mom-and-pop shops face disaster.
In the past five years, the rise of e-commerce has irrevocably changed the retail industry, tilting the landscape in favor of behemoths such as Amazon.com (ticker: AMZN) and Walmart (WMT) that can afford slick websites and fast, free delivery service. Now, without a vaccine or effective treatment for coronavirus available near term, these well-capitalized companies are likely to keep gobbling up market share at the expense of smaller operators.
This past week’s quarterly earnings reports from some of the most prominent U.S. retailers hammered home their advantage. The big-box chains— Home Depot (HD), Lowe’s (LOW), Target (TGT), and Walmart —all saw year-over-year sales climb by high-single or low-double digits, and all posted profits. Even with consumers curtailing their overall spending, these companies, whose stores remain open, saw demand increase.
Contrast that with apparel retailers Kohl’s (KSS) and Urban Outfitters (URBN), both of which experienced a more-than 30% drop in revenue, leading to quarterly losses. For these chains, growth in online orders wasn’t enough to offset forced store closures.
But it’s not just that large chains sell essentials; they have made themselves essential to consumers. “One of the things we’ve learned through this crisis is that the strong are just getting stronger,” says Dennis DeBusschere, head of portfolio strategy at Evercore ISI.
The situation looks bleak for smaller companies and mom-and-pop operations. According to Deutsche Bank Securities, 75% of small U.S. businesses have requested assistance from the government’s Paycheck Protection Program . And no wonder: As of mid-April, the number of small businesses open fell by as much as 80% in states such as New York and Michigan, both pandemic hot spots. (See our cover story on the crisis in small business .)
First-quarter results confirmed a trend long in place among U.S. retailers: Large, well-capitalized chains with big e-commerce units are growing rapidly, while smaller companies are struggling to stay relevant amid the virus pandemic.
Seventy percent of small retailers saw revenue decline in the past month, according to Deutsche Bank, and nearly a third cut the number of paid employees. About half reduced the total hours that employees worked. “This is a dark picture,” says the bank’s chief economist, Torsten Sløk.
And it is likely to persist. More than half of small businesses think that it will take at least four to six months— if not longer—for business to return to normal, but less than 20% say they have enough cash on hand to fund operations for more than three months. “We’re moving from a liquidity crisis to a solvency crisis,” says Sløk.
A protracted recovery would present other problems for small retailers, including limited access to capital and customers. People over age 55—those most vulnerable to the coronavirus—account for 40% of consumer spending, while younger people, many facing unemployment, are unlikely to pick up the slack. Moreover, most mom-and-pops have limited e-commerce platforms. These can’t begin to rival those of larger chains.
“The best brands that have taken the friction out of online shopping are going to get more of our time and our wallet, putting more pressure on the smaller ones,” says Eric Clark, a manager of the Rational Dynamic Brands fund, a mutual fund that invests in what it considers the most attractive brands in the Alpha Brands Consumer Spending Index.
“Increasingly, [smaller brands] are going to find it difficult to have the capital to compete with the convenience factor of these bigger brands.”
In many ways, the coronavirus has only accelerated trends already in place, notes Sløk. Despite the big chains’ ups and downs, investors who bought Home Depot, Lowe’s, Target, or Walmart in recent years have done relatively well, and all four could continue to outperform. Target and Lowe’s have the cheapest shares in the group, with price/earnings ratios around 17 times fiscal 2022 expected earnings.
Other metrics matter, too: In the past one- and five-year periods, Target and Home Depot generated the biggest gains in free cash flow, and more sales growth relative to their closest rivals. They also have the highest dividend yields, at 2.2% and 2.5%, respectively. While the next five years could prove more challenging, their long-term trajectory looks attractive.
For all businesses, the coronavirus is a reminder that no force is more powerful than nature. Unfortunately, for small retailers, the law of the jungle isn’t pretty.
