2018 has been kind to retail stocks— at least for the most part.
Sure, companies like Sears are still figuring out out how to grapple with increasingly difficult industry conditions. But even then, those restructuring efforts have proved to be positive for the sector’s equity prices on the whole.
The year-to-date results are undeniable. Retail companies in the S&P 500 have climbed 13% this year. That has crushed the benchmark, which slipped into negative territory for the year on Monday.
But when you strip out Netflix and Amazon— two of the retail gauge’s most influential companies — things start to look more dicey. After all, they are the two best performers in the index year-to-date, with Amazon increasing 29% and Netflix surging more than 66%.
The chart below shows just how much the retail industry has struggled to recover from an early-2018 decline that left it at multimonth lows. The blue line represents the sector with Amazon and Netflix stripped out, and it paints a far less compelling picture — one that has shown few signs of a rebound.
It’s troubling that Amazon and Netflix are so responsible for lifting the rest of the industry, especially when you consider that neither company really fits the brick-and-mortar mold. In fact, Amazon’s e-commerce efforts are actually blamed regularly for the plight of more traditional retailers, while Netflix’s only deliverable content is streaming video.
Putting even more pressure on the retail sector are lofty profit expectations that spiked following the passage of the GOP tax law. The chart below shows a measure of earnings revision breadth for the whole industry, as well as the index with Netflix and Amazon removed. And as you can see, a large number of firms saw profit estimates increase.
By that same token, the chart also shows the degree to which that breadth has declined in recent weeks. While Morgan Stanley sees this as a troublesome sign, the firm says it’s nothing compared with the drop that could be coming, especially if the tax boost wears off.
“Prior to tax reform, earnings revisions breadth was negative as analysts took down numbers for the industry group,” Mike Wilson, the firm’s chief US equity strategist, wrote in a client note. “There is potentially a long way for earnings revisions breadth to fall, which would cause more pain for traditional retail stocks.”
If you’re still not convinced that many traditional retail stocks are riding the coattails of tax reform, consider the final chart below. It shows the degree to which other profitability measures — EBIT and EBITDA — have failed to keep up with earnings per share.
The reason is simple: Those two gauges don’t include the impact of tax cuts and are suppressed by comparison. They’re also more accurate representations of core retail businesses, which helps explain why Morgan Stanley is so wary.
“This is a low quality move and most of the growth is coming from tax reform benefits rather than fundamental improvements to the businesses,” Wilson said. “We believe traditional retailers are more vulnerable than the average sector to the negative second order effects from tax, namely price competition and rising costs, especially labor.”
Leave a Reply
Leave a Reply
This site uses Akismet to reduce spam. Learn how your comment data is processed.
