November 6, 2017 Consensus

The Weekly Consensus – November 6, 2017 (Volume 9, Number 42)

The Big Story
Why Victoria’s Secret Isn’t Worried
Paul Alexander, CFA


News coverage of the retail industry has been dominated this year by bankruptcies, falling foot traffic, and the unyeilding encroachment of Amazon. So much of our attention has been drawn to the shift in spending from physical stores to the internet, that it has become tempting to judge a company’s future prospects through one simple, binary calculation: is this retailer heavily exposed to brick and mortar stores and malls? If yes, then its prospects are probably poor. If no, then perhaps it has a chance do well. According to this decision tree, L Brands, the parent company of the mall-based brands Victoria’s Secret and Bath and Body Works, may be in trouble. And recent events would seem to support that outlook. Sales at Victoria’s Secret have slumped recently amid discontinued product lines, millenials’ changing tastes, and new ecommerce-based competitors like Adore Me, True & Co, and Third Love. The stock market appears to have a pessemistic view of the company – shares of L Brands are off over 50% since the end of 2015. However, at the company’s annual analyst day last Thursday, L Brands reminded us that this binary decision tree is overly simplistic. Why? Because there is more to the world than U.S. malls and Amazon.

Specifically, L Brands is excited about China. After decades of avoiding international expansion, and then several years of testing tiny, partner-owned and operated Victoria’s Secret Beauty and Accessories (VSBA) stores in airports and tourist locations, the company is beginning to expand aggressively in China this year. The company opened a 26,000 square foot flagship in Shanghai this February and expects to have six full sized stores and 30 wholly owned VSBA’s in China by the end of this year. L Brands has moved fulfillment of Chinese ecommerce orders into China, it has expanded its presence on Alibaba, and next month, the company will host and film its annual Victoria’s Secret fashion show in Shanghai. Next year, the company expects to add another 15 mall based Victoria’s Secret stores and another 10 VSBA’s in the country. By the end of 2018, L Brands projects that its Chinese business will be generating $350-400 million in annual sales.

L Brands is bullish on its future because it projects that China could eventually become the company’s largest market. Of course, this owes to China’s enormous population and growing middle class. According to Demographia, China has over 100 cities with a population greater than 1 million people, and a McKinsey Global Institute report projects that this number could grow to over 200 cities by 2025. L Brands contends that the Chinese lingerie market is very fragmented among hundreds of small brands, and it has positioned Victoria’s Secret’s assortment and pricing to make is accessible to the masses.

Of course, it will take time for Victoria’s Secret to grow in China, and in the meantime, the brand’s core North American business does face challenges from ecommerce competitors and weakening mall traffic. With nearly $8 billion of annual revenues in the U.S. and Canada, a hypothetical 5% comp decline at the brand would wipe out a chunk of sales roughly the same size as the $400 million that the company hopes to gain in China by the end of next year.

Nevertheless, L Brands’ Chinese expansion is a reminder that retailers’ futures are not binary, depending only on whether they have the ecommerce chops to survive in a digital world. At least certain retailers have assets and options that may enable them to survive and grow, even in the face of the industry’s current challenges. It is too simple to assume that all brick and mortar retailers are headed toward a certain death – one that arrives in a brown cardboard box and free two day shipping.


Headlines of the Week

Starbucks to sell Tazo tea brand to Unilever for $384 million

Starbucks Corp. has agreed to sell its Tazo tea brand to Unilever PLC for $384 million in a deal that will enable the coffee giant to focus on a single brand of tea, Teavana. Unilever will acquire Tazo’s recipes, intellectual property and inventory. Starbucks acquired the brand in 1999 for $8.1 million, five years after Tazo was founded. Tazo is primarily sold in grocery, convenience and mass merchant stores. The deal for Tazo comes months after Starbucks said it would close all 379 of its Teavana locations and would focus on selling Teavana inside its coffee shops, rather than at stand-alone retail locations.


Apple becomes a $900 billion company

Apple rose to a record high in morning trade last Friday, briefly giving the company a valuation of over $900 billion for the first time. Shares were briefly up more than 3 percent at the opening bell on Friday, after the company reported earnings that blew past Wall Street expectations on Thursday night. Around the world overnight, thousands lined up outside Apple Stores, hoping to buy Apple’s new flagship phone, the freshly launched iPhone X.


Apparel & Footwear

Ann Taylor tries it hand at clothing rentals

Ann Taylor is testing a new way to get more of its merchandise into its shoppers’ hands. In a move to compete with companies like Rent the Runway, Ann Taylor is jumping into the clothing rental segment. Last month, the company quietly launched Infinite Style — the retailer’s new online subscription rental service gives shoppers access to “hundreds of Ann Taylor looks” for one flat fee, according to the company’s website. A $95 monthly fee enables customers to borrow up to three Ann Taylor items at a time — with unlimited exchanges, free dry cleaning, no due dates on returns, and free shipping on orders and returns. Shoppers can also purchase their favorite pieces at a discount, the website said. Unlike Rent the Runway and other subscription models that feature a broad assortment of designers, Infinite Style will only feature Ann Taylor apparel and does not include jewelry, accessories, or any goods from Loft or Lou & Grey, according to Racked.

Gap is selling subscription boxes for kids through Old Navy, after a successful run with baby clothes

Gap Inc. is launching another subscription box service — this time through its less-expensive Old Navy nameplate. Just last month, Gap’s baby division was seen ramping up its own subscription offering, but only for a limited time. Now, right in time for the holidays, Old Navy is selling a subscription box for kids, called Superbox. Similar to babyGap’s Outfit Box, the Old Navy Superbox is a quarterly subscription for kids ages 5 through 12. The boxes include six items and retails for $69.99, with more than $100 worth of clothes, according to Gap. The service is being marketed as a giftable option for shoppers, where customers are able to personalize the boxes without making too many selections.


True Religion emerges from Bankruptcy after 4 months

True Religion has come out of Ch. 11 Bankruptcy with a plan to close retail stores and reduce its debt from $471 million to $113.5 million by 2022. John Ermatinger, CEO said, “With substantial debt burden removed, we are eager to turn our full attention to implementing our forward-thinking strategy, including improving our retail operations, new partnerships and growing the brand’s digital presence.” True Religion cited athleisure as a main reason for the decline in its denim business. The bankruptcy plan includes an additional $60 million exit loan from Citizens Bank, the same entity who provided a $60 million operating loan for the company while it went through bankruptcy.
True Religion was founded in 2002 by Jeff Lubell who sold the company in 2013 to TowerBrook Capital Partners for $835 million.


Athletic & Sporting Goods

Lululemon Drops Under Armour Patent Lawsuit Over Sports Bras

Lululemon Athletica Inc., facing increased competition from rival athletic-apparel companies, has dropped a case in which it accused Under Armour Inc. of infringing patents for the designs of sports bras.  The companies jointly asked a judge to dismiss the lawsuit in federal court in Delaware, where Lululemon claimed several Under Armour sports bras infringed two patents for a criss-crossed strap design and copied the distinctive look of its Energy Bra.


Under Armour’s terrible year just got worse

Americans, it seems, are over Under Armour.  The onetime darling of the athletic wear industry announced that sales are down for the first time since 2005, even as it makes an aggressive push to expand into mainstream chains like DSW, Kohl’s and Famous Footwear. Although Under Armour racks up billions of dollars in sales each year, analysts say it has failed to drum up much loyalty among its customers. It has also been slow to resonate with women and has struggled to compete with larger rivals such as Nike and Adidas, which often offer lower-priced goods.


Cosmetics & Pharmacy

Walgreens Boots Alliance Seals Beauty Product Development Deal with Fareva

Walgreens Boots Alliance announced that it has commenced its partnership with Fareva for the manufacture and supply of own beauty brands and private label products. It’s a 10-year deal that will capitalize on Fareva’s significant research and development capabilities and enable the company to accelerate its global product strategy, Walgreens Boots Alliance stated.  Under the terms of the agreement, Fareva has acquired BCM, Walgreens Boots Alliance’s contract manufacturing business, which operates factories in the U.K., France and Germany.


Henkel Acquires Shiseido’s US Professional Hair Care Business

Henkel has signed an agreement to acquire Shiseido’s US professional hair care subsidary for $485m, in a bid to broaden its brand portfolio and strengthen its professional hair business in the region.  The agreement will see the German multinational take over Zotos International, Shiseido’s Connecticut, US-based professional hair company, and its brands including Zotos Professional, AGEbeautiful and Joico. The transaction follows Henkel’s acquisition of Nattura Laboratorios and its professional hair care brand Pravana; its third in recent years after acquiring US companies Sexy Hair, Alterna and Kenra in 2014 as part of the company’s drive to expand in the US professional hair market.

The Estée Lauder Companies Achieves Outstanding Fiscal 2018 First Quarter Results

The Estée Lauder Companies Inc. reported financial results for its first quarter ended September 30, 2017. The Company achieved net sales of $3.27 billion, an increase of 14%, compared with $2.87 billion in the prior-year quarter. Incremental sales from the Company’s recent acquisitions of Too Faced and BECCA contributed approximately 4 percentage points of the reported sales growth. Net earnings rose 45% to $427 million, compared with $294 million last year. Diluted net earnings per common share increased 44% to $1.14, compared with $.79 reported in the prior year.


Discounters & Department Stores

Wal-Mart will hold parties — yes, parties — in its stores this holiday season

Wal-Mart is gearing up for the holiday season this year with plans to invest even more in the in-store shopping experience. For Wal-Mart, that means parties. The big-box retailer plans to hold more than 20,000 parties at its stores over the next two months, with the first event, called “Toys That Rock,” taking place nationwide this Saturday. Wal-Mart’s other events will include “Parties That Rock” and “Gifts That Rock,” where attendees can receive curated gift guides and toy catalogs. Its overarching holiday marketing campaign this year is dubbed “Rock This Christmas,” the company announced Wednesday.

Sears issues searing response to WSJ story

Sears Holdings lashed out at The Wall Street Journal over a more than 2,000-word story detailing the decline of the retailer and how it’s “scrambling” to maintain vendors. In a company blog post, the retailer called out the Journal and described the story as “yet another rehash of inaccurate assertions and negative speculation about Sears Holdings and its future.” Company spokesman Howard Riefs told Retail Dive that Sears had no further comment. The Journal story offers a historical account of the company’s sales declines and financial struggles, and makes note of suppliers who have pulled back from Sears or have tightened financial terms.


JCPenney Launches Wearables, New Bridal

J.C. Penney is revamping its fine jewelry department. The department store is branding its fine jewelry product with a new trademark that emphasizes the store’s long history, “JCPenney Co. Fine Jewelry, Est. 1902.” The department store also has rolled out smartwatches from brands like Samsung, LG and Garmin in 245 stores nationwide.


Grocery & Restaurants

Dunkin’ sale chatter resurfaces

The investment firm JAB Holding Co. has bought a lot of coffee and breakfast chains recently. Dunkin’ Brands Inc.’s flagship concept, Dunkin’ Donuts, sells coffee and breakfast. In Wall Street’s eyes, that means JAB may soon come for Dunkin’, and talk of a potential buyout helped Dunkin’s stock surge nearly 8 percent last Monday.


HelloFresh is growing three times faster than Blue Apron and is worth twice as much

HelloFresh, the second-biggest U.S. meal kit competitor by market share, went public last week on the Frankfurt Stock Exchange. It joins its beleaguered larger competitor Blue Apron on the public markets. So far, the market is treating their IPOs about the same. But financially, a lot separates them. At about $1.6 billion, HelloFresh is worth more than twice as much as Blue Apron at $800 million. HelloFresh also has higher revenue and lower net losses than Blue Apron. A similar business, Plated, recently sold to Albertsons.

Papa John’s CEO blasts NFL, says weak ratings hurt sales

The controversy over NFL player protests during the national anthem has put Papa John’s International Inc. on the offensive, pulling some ads from games and shifting to digital marketing in an effort to improve sagging sales. John Schnatter, the Louisville-based chain’s founder and CEO, had harsh words for the league in a conference call following the release of third-quarter results late Wednesday. “The NFL has hurt us,” Schnatter said. “More importantly, by not resolving the current debacle in a manner that was satisfactory to both sides, it has hurt Papa John’s shareholders.” The Louisville-based pizza chain blamed weaker-than-expected same-store sales this year not only on poor NFL ratings, but on the company’s very association with the league.

Home & Road

Rent-A-Center to Explore Alternatives

The nation’s largest rent-to-own operator announced that its board has initiated a process to explore strategic and financial alternatives with an eye to maximizing stockholder value. “Rent-A-Center remains committed to taking actions that are in the best interests of the company and all of its stockholders, as demonstrated by the commencement of what will be an extensive review of both strategic and financial alternatives,” the company said in a statement.  The retailer made the announcement on the same day that it reported its sales for the third quarter were $644.0 million versus $693.9 million in the year-ago period. Same-store U.S. sales fell 5.1%. Its net loss and diluted loss per share, on a GAAP basis, were $12.6 million and $0.24, compared to net earnings and earnings per share of $6.2 million and $0.12 last year. Rent-A-Center noted that there it could no assurance that the board’s exploration of strategic and financial alternatives will result in any particular action or any transaction being pursued, entered into or consummated.

Newell Brands Misses Street 3Q Forecasts

Newell Brands Inc. reported third-quarter earnings of $234.4 million.  The Hoboken, New Jersey-based company said it had profit of 48 cents per share. Earnings, adjusted for non-recurring costs, were 86 cents per share. The results fell short of Wall Street expectations. The average estimate of 10 analysts surveyed by Zacks Investment Research was for earnings of 92 cents per share. The consumer products company posted revenue of $3.68 billion in the period, which also did not meet Street forecasts. Eight analysts surveyed by Zacks expected $3.7 billion.  Newell Brands expects full-year earnings in the range of $2.80 to $2.85 per share, with revenue in the range of $14.7 billion to $14.8 billion.  Newell Brands shares have dropped 8 percent since the beginning of the year, while the Standard & Poor’s 500 index has climbed 15 percent. The stock has dropped 15 percent in the last 12 months.

Wayfair Posts Q3 Loss Per Share, Despite Increase in Net Revenue

A surge in new hires and investments in technology and its logistics and delivery networks were major contributors to Wayfair Inc.’s non-GAAP net loss per share of 65 cents for its third quarter.  For this period last year, the home furnishings e-tailer posted a non-GAAP net loss of 54 cents per share. The home furnishings e-tailer reported net revenues of $1.2 billion for Q3, an increase of $336.7 million, or 39.1%, over the same period last year. Wayfair’s GAAP net loss for Q3 was $76.4 million, while its non-GAAP net loss was $56.6 million, compared with $60.9 million and $45.7 million, respectively, for the same period in 2016.  Wayfair also reported an increase in active customers of 39.2% year-over-year, for a total of 10.3 million, and last 12-month (LTM) net revenue per active customer of $408, an increase of 0.5% year over year.

Jewelry & Luxury

Luxury brands are changing how they operate internally to react faster to customers

Luxury brands, feeling the heat from agile fast-fashion and online-only retailers, are speeding up production processes and reacting quicker to customer behavior by changing how they organize their businesses. “I know people are sick of hearing about the ‘customer journey,’ but our focus right now is on creating an efficient, on-demand, well-organized customer journey,” said Lisa Pomerantz, CMO of Kering-owned luxury brand Bottega Veneta. “Organizations that are siloed are no longer going to be able to properly reach today’s customer.” Pomerantz spoke at the Decoded Fashion Summit in New York about the brand’s internal shift to be more accommodating to a modern customer’s needs, including repositioning departments to work cross-functionally and embracing the idea that organizations need to continually be evolving.


Spot the difference: why DIY diamonds pose a threat to big miners

Amish Shah is the third generation of his family to work in the diamond business. But the first to sell stones grown in a laboratory rather than dug out of mines in far-flung corners of the world — a process that threatens to shake up the $80bn diamond jewellery market built on notions of love and marriage. By mimicking the conditions at the core of the earth, machines are now able to produce diamonds that are identical to natural ones — in weeks, rather than billions of years. Mr Shah insists they are better quality, cost less and leave a smaller carbon footprint, which he hopes will make them more attractive. “It’s bigger and better,” says the 42-year-old, whose grandfather started in the business in the Indian city of Kolkata in 1933. “If someone puts a one carat [diamond] on their hand that is mined or a carat and a half that is a created diamond — what makes the biggest difference to them? Who doesn’t want a bigger and more brilliant diamond?”

Labs Launch Credit Card-Sized Grading Reports

HRD Antwerp and the International Gemological Institute (IGI) have both released credit card-sized diamond reports, aiming to make grading more efficient for traders. The two Antwerp-based laboratories unveiled the polished-diamond identity cards this week, though their products are unrelated to each other. Both organizations’ reports contain the stone and the report together in a sealed card, making them easier to ship, store and sell.


Office & Leisure

FAO Schwarz is back

The nation’s most iconic toy brand is making a comeback — just in time for the holidays. The Bon-Ton Stores is launching FAO Schwarz toy departments in 186 of its department stores and also on its website. The famous toy brand will be featured at select locations across Bon-Ton’s network of department stores (including Bon-Ton, Boston Store, Bergner’s, Carson’s, Elder-Beerman, Herberger’s and Younkers) and also on its website. The merchandise mix will include such FAO classics as its “piano mat,” which Tom Hanks danced on in the movie “Big.” In addition to its deal with Bon-Ton, FAO has opened a holiday pop-up in Manhattan, at the tony Bergdorf Goodman store on Fifth Avenue. In October 2016, Toys “R” Us sold FAO to ThreeSixty Group, which designs, manufactures and distributes toys and other consumer products under a portfolio of owned and licensed brands — including, Sharper Image, Black Series, Discovery Kids, Smithsonian, and Animal Planet — to over 70,000 retail stores across the country.

Waterstones owner Mamut drafts in Rothschild to start next chapter

Waterstones, which Mamut bought from HMV in 2011, has weathered the rise of e-readers to return to profits in the past year. It is understood that Mamut brought in NM Rothschild over the summer to prepare the ground for a possible sale or a refinancing to replace Waterstones’ loan facility with Russian Commercial Bank. However, the process is not expected to begin in earnest until Waterstones is through the Christmas rush, which produces 85 per cent of the retailer’s profits. Meanwhile, Mamut has been hit by the state bailout of the Russian bank Otkritie, which is reportedly asking backers including him to help repair its finances. Waterstones reported a pre-tax profit of £9.9m in the year to April 2016. According to the Sunday Times the firm’s next set of accounts will show underlying earnings of almost £40m, meaning the business could command a value of between £200m and £300m.

Technology & Internet

Amazon launches AR app

Amazon launched this week an augmented reality (AR) app for iPhones: ARView, which lets shoppers virtually view an item in their iPhone camera’s view of a space. Categories of products available for viewing in ARView include living room, home décor, bedroom, electronics, toys and games, and Amazon Echo devices.


Will customers want to shop at no-checkout store?

No SKUs, no scans? No problem: A convenience store that charges customers for their purchases without using registers or any other typical checkout system is opening in Cork Ireland in the first quarter of 2018. “There’s nothing in the store that scans a barcode,” said Kieran Powell, spokesperson for Everseen.  Everseen has developed what it calls a shelf-checkout system and branded it 0line (pronounced “zero line”). The technology tracks, tallies and charges customers for their purchases without using registers, bar codes, Bluetooth or Beacon technology. “It’s all computer vision AI (artificial intelligence) and biometrics when you first enter the store,” Powell said.

Finance & Economy

US consumer spending posts largest gain since 2009

U.S. consumer spending recorded its biggest increase in more than eight years in September, likely as households in Texas and Florida replaced flood-damaged motor vehicles, but underlying inflation remained muted.  The Commerce Department said consumer spending, which accounts for more than two-thirds of U.S. economic activity, jumped 1.0 percent last month. The increase, which also included a boost from higher household spending on utilities, was the largest since August 2009.


U.S. Consumer Confidence Just Hit Its Highest Level in Almost 17 Years

U.S. consumer confidence rose more than expected in October to the highest in almost 17 years as Americans grew more confident about the economy and job market, according to figures from the New York-based Conference Board.  Jumps in the Conference Board’s measures of the present situation and expectations signal Americans are becoming more upbeat about the economy and employment as the labor market improves and stock prices climb to records. Improvement in household confidence helps underpin their spending, the biggest part of the economy.