March 12, 2018 Consensus

The Weekly Consensus – March 12, 2018 (Volume 10, Number 11)

The Big Story
Amazon the Great Inches Closer to Tears
Paul Alexander, CFA

“When Alexander saw the breadth of his domain, he wept for there were no more worlds to conquer.” The Greek biographer Plutarch is widely credited as the author of this famous (though misquoted) line regarding the exploits of Alexander the Great. If Plutarch were alive today, and penning a slightly melodramatic biography of modern retail, he might argue that the industry’s modern conqueror, Amazon, is getting closer to its own weeping session.

While Amazon isn’t out of worlds to conquer just yet, it took a step closer last week, when it announced that it will offer Prime membership at a discounted rate ($5.99 per month, versus the normal rate of $12.99) to people enrolled in Medicaid. This comes after a similar move last year to offer discounted membership to people who receive government food assistance. Amazon has received praise for extending these discounts to less economically-advantaged consumers. But these steps can also be interpreted not as altruism, but as an effort to conquer a new target customer for Amazon Prime: lower-income households.

According to Consumer Intelligence Research Partners, Amazon has 90 million Prime members in the U.S., and these customers are notably more valuable than non-members; average annual spending on Amazon for members is $1,300, which is almost twice the non-member average of $700. However, Prime membership is skewed toward higher-income consumers. According to a 2017 estimate by Piper Jaffray, households with an annual income greater than $112,000 are 30 percentage points more likely to be Prime members than households with incomes between $21,000 and $41,000. Prime figures look still worse at the lower-earning end of that income range. Accordingly, Amazon may look at lower-income households as a new conquest.

And for good reason. Not only are Prime members more valuable, but these moves come at a time when Prime membership growth may be stalling. According to a Morgan Stanley survey conducted in the third quarter of 2017, the percentage of American households that are Prime members has been steady since early 2016. This observation would seem to conflict with Amazon’s recent report that 2017 was a record year for Prime sign-ups both in the U.S. and globally (unless there were also many Prime cancellations). However, the reality that there are a finite number of households in the U.S. to bring onto Prime is inescapable, and with every new member, Amazon inches closer to saturation.

Which leads to two final parallels between Amazon and Alexander the Great – parallels that suggest that while Amazon is closer than ever to conquering its home market, it won’t be weeping for lack of future opportunity anytime soon. The first is that just like Alexander, Amazon’s next frontier is expansion to and domination of new countries. Currently, Amazon’s business is weighted toward North America, with only 30.5% of sales originating from the company’s “international” market segment. The last parallel is that Alexander never fully conquered India, and he never stepped foot in China. Amazon is currently investing heavily in India, but finding a formidable competitor in Flipkart, and Amazon’s marketshare in China is reported to be under 1%, thanks to challenging regulations and the dominance of domestic incumbents and Alibaba.

So at least for the near term, Amazon the Great can be proud that it is closing in on dominance on one continent, but it can put away the tissues.


Headlines of the Week

Toys ‘R’ Us Is Prepping to Liquidate Its U.S. Operations

Toys “R” Us Inc. is making preparations for a liquidation of its bankrupt U.S. operations after so far failing to find a buyer or reach a debt restructuring deal with lenders, according to people familiar with the matter. While the situation is still fluid, a shutdown of the U.S. division has become increasingly likely in recent days. Hopes are fading that a buyer will emerge to keep some of the business operating, or that lenders will agree on terms of a debt restructuring. The toy chain’s U.S. division entered bankruptcy in September, planning to emerge with a leaner business model and more manageable debt. A new $3.1 billion loan was obtained to keep the stores open during the turnaround effort, but results worsened more than expected during the holidays, casting doubt on the chain’s viability. The news sent shares of the biggest toymakers tumbling in late trading. Mattel Inc. fell as much as 6.1 percent, while Hasbro Inc. declined 3 percent.


Amazon goes after swipe fees with its push into checking account services

Jeff Bezos changed the way America shops. Now, he wants to change how it pays for things. With a foray into financial services, Inc. could disrupt the decades-old card payments system, a move that some say could save the retailer $250 million a year in swipe fees. That could be bad news for the likes of Visa Inc. and Mastercard Inc., as well as a host of other players.



Apparel & Footwear

L Catterton-Backed Brand GXG Plans $300 Million IPO

GXG, the Chinese men’s fashion retailer controlled by L Catterton Asia, is planning a Hong Kong initial public offering that could raise about $300 million, according to people with knowledge of the matter. The Ningbo-based street fashion brand is working with investment banks on the proposed share sale. It is preparing to list as soon as this year. L Catterton Asia, the consumer-focused private equity firm backed by luxury giant LVMH Moet Hennessy Louis Vuitton SE, bought a majority stake in GXG in 2016. The company, founded in 2007, operates more than 2,100 stores in China and employs over 4,000 workers, according to a November statement. GXG ran the best-selling men’s clothing shop during the Singles’ Day sale on Alibaba Group Holding Ltd.’s Tmall e-commerce platform in 2016.

Walking Company Steps Into Bankruptcy

The Walking Company is seeking bankruptcy protection for the second time in a decade, and this time the blame goes to UGGs shoes. Following a 2009 bankruptcy declaration and reorganization, the company is again seeking more advantageous lease terms on its 200+ stores. The retailer already has worked out a Chapter 11 plan with key creditors that includes a $10 million equity investment and $50 million in bankruptcy and exit financing, which will allow its stores to stay open during the restructuring period. In 2009, the retailer was feeling the effects of the Great Recession. This time, its problems stem from a more specific source: the decision late in 2016 by UGGs maker Deckers Outdoor to pull the popular brand from the Walking Co. “As a result of the difficult environment for store-based retailing in 2017, Walking Co. could not replace the lost UGG sales fast enough,” said CEO Andrew Feshbach in a court declaration. The Walking Co.’s proposed restructuring plan is backed by its current shareholders, CEO Feshbach and two investors from Kayne Anderson Capital Advisors.



Athletic & Sporting Goods

Under Armour, Yankees’ Aaron Judge never closed endorsement deal, now, he’s wearing Adidas

In 2014, Under Armour had the foresight to sign Aaron Judge to an endorsement deal while the current New York Yankees star was still in the minor leagues.  Last July, The Baltimore Sun reported that the Baltimore-based apparel and footwear company was negotiating a long-term extension with Judge, who went on to hit a rookie-record 52 home runs in 2017 and was named American League Rookie of the Year.  But the sides never closed the deal.  And now Judge, in spring training with the Yankees in Tampa, Fla., has been wearing Adidas.

Nearly 700 Cabela’s employees in Sidney volunteer for buyouts

About 300 Cabela’s employees in Sidney have taken Bass Pro’s buyout offer as the outdoors retailer winds down the headquarters operation in Nebraska. They will leave the company this week.  Nearly 400 more Cabela’s workers also “volunteered to exit,” Bass Pro said Thursday, but the company is postponing any action on those people until it determines its needs and what opportunities could be available in Sidney or elsewhere.

Cosmetics & Pharmacy

Rite Aid Asset Transfer to WBA 85% Complete

Rite Aid reported the successful asset transfer of more than 85% of the stores the company is selling to Walgreens Boots Alliance. As of March 2, Rite Aid has transferred 1,651 stores and related assets to WBA, and has received cash proceeds of $3.6 billion, which the company continues to use to reduce debt.  Under the Asset Purchase Agreement, WBA will purchase a total of 1,932 stores, three distribution centers and related inventory from Rite Aid for an all-cash purchase price of $4.4 billion on a cash-free, debt-free basis. The majority of the closing conditions have been satisfied, and the subsequent transfers of Rite Aid stores and related assets remain subject to minimal customary closing conditions applicable only to the stores being transferred at such subsequent closing, as specified in the Asset Purchase Agreement.  Rite Aid expects to complete the store transfer process in the spring of 2018. After all stores are acquired, stores are planned to be converted to the Walgreens brand in phases over time.

The Vitamin Shoppe in Search of New CEO

The Vitamin Shoppe named Alex Smith executive chairman and announced the search for a new CEO following the departure of current CEO Colin Watts, who is staying with the company through the end of May to ensure a smooth transition.  Despite a strong market base, the new specialty retail chief executive will be challenged with the continued erosion of customers from in-store to online. Though, current leadership has a plan in place, Smith noted. “Overall, 2017 yielded disappointing results,” Smith said. “Over the past couple quarters, Vitamin Shoppe has begun a turnaround and signs of progress are already visible. We have also reached a mutual agreement with our CEO, Colin Watts to transition the business to new leadership by May. During this time, the entire organization will be committed to implementing the New Base Plan developed by management. In my new role as executive chairman, I will work closely with our leadership team in that effort while we execute our search for a new CEO.”

Shiseido Builds ‘Prestige First’ Central Strategy, Puts Focus on 4 More Brands

Shiseido Company’s new three-year plan beginning this year will see the company implementing new strategies to accelerate growth and be among the top three companies in the global prestige cosmetics market, while maintaining its presence in Asia Pacific and Japan.  The three year-plan is the second phase of its six-year medium-to-long term strategy titled “VISION 2020″ developed in 2014. As a result, the company surpassed 1 trillion JPY in sales, a target originally set for 2020. Currently, Shiseido intends to proceed with digital acceleration, new business development and new value creation through innovation, while increasing active marketing investment.


Discounters & Department Stores

Costco says extra profit from tax cuts will be shared with employees

Many retailers have announced plans to spend their tax-cut windfalls on one-time employee bonuses or more enduring wage increases. As retail pay is boosted, Costco intends to keep compensation for its more than 239,000 workers ahead of the pack, executives said as the company reported its quarterly results. Costco’s tax benefit in its fiscal second quarter was $74 million or 17 cents a share. That helped the Issaquah-based retailer post $701 million in profit, $1.59 a share, and beat Wall Street analysts’ expectations. Costco sales and membership fees were up 10.8 percent to $33 billion in the quarter, which ended Feb. 18 and included most of the holiday shopping season.

J.C. Penney Rearranges Execs, Cuts 130 Jobs in Home Office

In a corporate reshuffle at its Dallas home office, J.C. Penney has promoted James Starke to head of merchandising for men’s, children’s, home, and jewelry. Starke’s previous title at the department store chain was listed as senior vice president and senior general merchandise manager of men’s apparel, children’s apparel, and jewelry. He first took on that particular title in November. Prior to that, Starke oversaw only the men’s and kids’ departments.

How Kohl’s uses stores in pursuit of ‘operational excellence’

While retailers across the nation have been forced to close brick-and-mortar stores and refocus efforts on e-commerce distribution, Kohl’s is bucking that trend. “We have a strong belief that physical stores matter,” Sona Chawla, chief operating officer for Kohl’s, told attendees at RILA’s supply chain conference last week. Customers “want to shop in both the digital and physical worlds,” she said. And very few Kohl’s customers shop exclusively online, Chawla added. The retailer is honing in on two company priorities: driving traffic and operational excellence.


Grocery & Restaurants

Bravo Brio to be acquired for $100M

Bravo Brio Restaurant Group Inc. has agreed to be sold to Spice Private Equity Ltd., a Zug, Switzerland-based division of GP Investments Ltd., in a deal valued at about $100 million, the companies said Thursday. Bravo Brio expects to report annual sales of more $400 million for the year ended Dec. 31.

CIC Partners sells Taco Mac

Private-equity firm CIC Partners L.P. has sold the 27-unit Taco Mac sports bar-wing brand to a group of investors, an Atlanta-based investment group has announced. Dallas-based CIC Partners first invested in Taco Mac’s parent, Tappan Street Restaurant Group Inc. of Atlanta, in July 2012 when it had 28 units. Taco Mac restaurants are in Georgia, Tennessee and North Carolina.

Kroger cites margin pressure in 2018 outlook

Kroger Co. said it expects margin pressure to squeeze earnings in 2018 as the company continues to invest in its Restock Kroger initiative. The Cincinnati-based retailer reported sales and earnings for the fourth quarter and year that met analysts’ expectations, but the company saw its share price fall as investors fretted over the outlook for the year ahead. The company said that because of the benefits of tax reform, it would accelerate its investments in Restock Kroger, which involves a range of data-driven merchandising initiatives and spending on higher wages and other employee benefits, among other efforts. The company said that some investments that had been planned for future years would be made this year instead, although the benefits won’t be reflected in improved margins until next year and the year after.

Home & Road

The Cookware Company Completes Acquisition of Two Dutch Brands

The Cookware Company has successfully completed the acquisitions of BK Cookware and Koninklijke Van Kempen & Begeer, two subsidiaries of the Netherlands-based Royal Delft Group. While financial details of the transaction were not released, The Cookware Company did say it paid about $13.25 million for shares of the two brands. BK Cookware develops and manufactures cooking utensils and cutlery under the labels Gero and BK, a premium brand. Established in 1789, Koninklijke Van Kempen & Begeer is an exclusive brand of silver and silvered cutlery

Nordstrom, Anthropologie Partner on Home Collection

Nordstrom will begin offering an Anthropologie Home collection online and in select stores later this month, the result of a new partnership between the two retailers. The Anthropologie Home collection includes more than 200 items in the kitchen, dining and entertaining, bed and bath textiles, room décor, stationery and hardware categories. The collection debuts March 19.

Jewelry & Luxury

Claire’s Planning to File for Bankruptcy, Report Says

Claire’s Stores, the mall staple that specializes in teen jewelry and accessories, is planning to file for Chapter 11 in the coming weeks, according to a report in Bloomberg that quoted unnamed sources. The company could not be reached for comment at press time. According to the report, the mall chain is working out a deal whereby Apollo Global Management, which has owned the company for the past 11 years, would cede control to the company’s lenders, Elliott Capital Management and Monarch Alternative Capital.


Office & Leisure

Sales at toymaker Lego fall for the first time in 13 years

Lego’s sales fell last year for the first time since 2004 as the Danish toymaker struggled with tough retail markets in Europe and North America, highlighting the challenges facing the new chief executive. The privately owned company, famous for its colorful plastic bricks, could be facing its biggest test since flirting with bankruptcy in the early 2000s after a sudden halt to more than a decade of strong growth. Sales fell 8 percent to 35 billion Danish crowns ($5.8 billion) in 2017, compared with a 6 percent increase in 2016 and a far cry from the 25 percent growth achieved in 2015. The company said overall consumer sales were flat, but the figures were affected by a clean-up of inventories that were set high at the beginning of the year in anticipation of growth. Lego saw “strong double-digit” growth in China, while most established markets in North America and Europe declined. Lego said in September it would lay off 8 percent of staff and that it had pressed the “reset button,” acknowledging its business had grown too complicated.

Technology & Internet

Boxed reportedly rejects Kroger’s $400 million purchase offer

Boxed Wholesale, which sells snacks, paper towels and other household products in bulk, rejected a $400 million acquisition offer from Kroger Co. and will pursue a new funding round to remain private, according to a person familiar with the matter. Boxed also had preliminary talks with Inc., Target Corp. and Costco Wholesale Corp., but Kroger was the only company to submit a bid, the person said.


Two private equity firms plan to buy CommerceHub for $1.1 billion

Private equity firms Sycamore Partners and GTCR announced plans to acquire e-commerce services vendor CommerceHub Inc. for $1.1 billion in an all-cash deal.

Finance & Economy

Jobs report surprise: 313,000 added in February

The US economy added 313,000 jobs in February. That was much stronger than economists expected and the biggest gain since July 2016, according to Labor Department figures.  “The headline number is pretty outstanding,” says Cathy Barrera, chief economist at ZipRecruiter, a job recruitment site.  The unemployment rate stayed at 4.1%, the lowest in 17 years.  Wages grew 2.6% compared with a year earlier, a few notches below the pace in January.


US trade deficit jumps to more than 9-year high

The U.S. trade deficit increased to a more than nine-year high in January, with the shortfall with China widening sharply, suggesting that President Donald Trump’s “America First” trade policies are unlikely to have a material impact on the deficit.  The Commerce Department said the trade gap jumped 5.0 percent to $56.6 billion. That was the highest level since October 2008 and followed a slightly upwardly revised $53.9 billion shortfall in December.


30-year mortgage hits highest point since 2014

Mortgage rates increased for the ninth consecutive week, as the 30-year rate reached its highest point since 2014, according the Freddie Mac’s latest Primary Mortgage Market Survey.  “The U.S. weekly average 30-year fixed mortgage rate rose three basis points to 4.46% in this week’s survey, its highest level since January 2014,” said Len Kiefer, Freddie Mac deputy chief economist.