Editor’s Notes: Christopher Ng Wai Chung, our Early Retirement Masterclass trainer noted in an earlier post that some REITs have ascended to all time high prices. This has a knock on effect on three things.
First, dividend yields which are a function of annual dividends paid out divided by stock purchase price has been compressed because prices have risen while dividends remain constant.
Second, higher prices mean that investors late to the part have to assume higher risks while being paid lower dividends. This is a net negative for retail investors new to the scene and potentially catastrophic for people who are unaware of what various REITs counters do and how to view them. This article which focuses on how to assess retail strengths in terms of qualitative assessment is useful for REITs investors who need to ascertain whether to buy a REIT focused on retail or focused on other property operations.
Third, because of the growing powers of Amazon as a business to deliver on both pricing and convenience advantages, this article is also in part to warn investors who are overly weighted on REITs which focus on retail. Granted, there aren’t many such REITs which are pure retail plays (and as noted later in the article, not all are bad!) but investors should stay informed anyway and try to diversify away such risks where possible. REITs in general have had some good years. But markets and economies are both cyclical which means that getting in at unreasonable prices hurt your bottom line when the markets calm back down.
Article Objective: While I’ve placed a greater emphasis in the above three points on how REITs and retail investors in Singapore are affected, please note that this also applies to specific retail stocks as well such as Best Buy. You can use the learnings in this article to inform yourself more when buying into retail stocks (Challenger) or into retail exposed stocks (such as REITs).
Fundamentally, whether you are a value investor chasing immense capital growth or a dividends investor chasing passive income, you will be well served being better able to use a value proposition framework to evaluate competitive business advantages.
From YouTube bogeyman “Hey Folks, it’s Imran”, to Mr goody two shoes “Hi this is Benjamin Tan here”, to handsome lady killer, Cristiano Ronaldo doing his cheesy dance, endorsing Shopee.
One thing we know for sure between these people: e-commerce is a hot topic in the market right now!
While Amazon, E-bay, JD.com, Alibaba, Pingduoduo, Craigslist, Rakuten and of course our sweet sweet Shopee seems to be ruling the sky and earth, Retailers, on the other hand, are being battered down like a recruit in Tekong.
- Centre point shopping mall is currently struggling to stay relevant.
- Metro is closing down its stores leaving only 2 alive in Singapore.
- Renowned retailers such as Toys r us (USA), Sears & Kmart and Forever 21, raised their white flags and filed for bankruptcy.
And most unfortunate of all, Singaporean’s last bastion of cheap levy free goods, Duty-Free Singapore just announced to be closing their store at Changi airport by 2022.
It just begs the question – what would Singapore, a shopping paradise look like without a shopping mall 20 years from now? And how should investors who are vested in retail malls think about such trends?
Is it wise to stay away from stocks related to brick and mortar as retail investors? ie; REITs & Other Retail Stocks
68 different major retailers filed for bankruptcy between 2015 till now, coinciding with the rise of Amazon as a powerhouse for retail consumers in terms of price and convenience.
The above represent popular brick and mortar, which have filed for chapter 11 (Which means restructuring, different from chapter 7 which means bye-bye forever).
It’s no wonder tons of people out there are thinking it’s all sunshine teddy tubbies and rainbows for e-commerce, and it’s doom and gloom with the grim reaper saying “I will be back” for a traditional retailer.
However, I have a reasonable case to fight for retail that readers can not only learn from this article BUT also capitalise on this situation very lucratively.
All I have to say succinctly is this: The media is biased. They sell base on sensationalism. Retail is by far anywhere close to 100% dead.
They do not tell you which ecommerce company is losing money.
(Flipkart, Paytm, Make my trip India, Zwiggy, Zomato, Wayfair)
They do not tell you which brick and mortar stores have managed to turn around successfully. (Best Buy, Wal-Mart, Target, Costco, Kohl)
And most certainly they do not tell you the real reason why some companies (retailers & e-commerce) go bankrupt. (Leverage buyouts, Bad management decision, Bad Management, too little cash flow)
Retail stocks are currently abandoned and unloved; e-commerce companies are the golden boy of Wall Street and downtown.
Rapid revenue growth regardless of net profit or loss seems like the new in thing. Grow more revenue; lose more money. Who cares?
There is a massive disregard by investors to the fundamentals of both online and offline.
Good news is, at every overly depressed industry; there will be a lot of hidden opportunities waiting for the keen eyes of the value investors!
Don’t get me wrong; retailers are facing relevancy problems, many are going to go fall, many more will struggle. Those who choose to stay and be a Nokia will most definitely be gone.
The future of retail and online is neither just purely e-commerce nor 100% brick & mortar but a seamless integration of both.
- As you can see from Amazon purchasing Whole Foods
- Taobao setting up a retail shop in Funan centre.
- Walmart and many big retailers spending large amount of money to improve their online website and delivery system which resulted in a turnaround.
But at the end of the day, it does not matter if it comes from online or offline; consumers only care for 4 basic factors; ultimately which business brings them the most value and those who do will get rewarded handsomely. We wouldn’t want to be left out of those stocks we failed to identify, would we?
Step 1 – 4 Basic Consumer Behaviour Factor
One key problem in investing in “undervalued companies”, is that it might turn out to be a value trap, thus value investors ben graham’s method always diversify their stocks to prevent catastrophic losses if they were so unlucky. In order to avoid a value trap as much as possible, we must upgrade our checklist.
Understanding 4 qualitative factors because even good quantitive numbers can be deceptive and might turn into a booby trap.
If those factors are absent, we must be able to identify if they have the abilities to build back either of those 4 to turn around the company.
Regardless of your business sector, consumers only care about 4 basic keys to help them decide what to purchase. It is up to the management of the company to execute initiatives to achieve those factors and maintain it sustainably.
These are the 4 factors.
- Unique Product
- Unique services
- Brand (This is not one of the main factor as this is a consequence of good customer proposition – you cannot have a good brand but yet shitty factors)
As Amazon CEO; Jeff Bezos would put it in one of his interviews: “If a business have one of this factor it will do well, if it has two, it would dominate the market. Most small companies struggle to come out even with one.” – Jeff Bezos
Amazon has identified that they are always about Low prices and convenience for their customer and execute it effectively thus they performed phenomenally well.
In fact, this picture will bring more clarity into why some companies are performing well and while some are in deep…. waters. Usually, any business that dealt with unique product or services is thriving and unscathed. Think of Haidilao, Disney, Coke and Bubble tea store Koi and Liho.
Speaking of bubble tea I have recently just been to Suntec City and Tampines hub noticing Liho have 2 shops at the top floor and bottom basement while Koi have not 1, not 2 but 3 stores at Tampines shopping centres itself! Man! Talk about proper store allocation!
On the other hand, companies, which offer convenience and price, are most of the time dogging it out with one another.
Grab, Gojek, Comfortdelgro and Uber. Singtel, Myrepublic and Starhub. In fact, Uber bailed out and Starhub announced to cut off dividend payments in the future. Needless to elaborate more on how competitive these industries are.
The moral of the story is, find out what competitive advantage it has. We would like to stick to Group 1 and 2 as much as possible.
- Group 1 -> If it has anything associated with unique product or service; double-check it with the annual report, vice versa, you are likely to be in the safe area.
- Group 2 -> If it is all got to do with about price and convenience, you would like to tread lightly. Investigate and invest with care.
- Group 3 -> Lastly if it does not have price or convenience anymore, sells commodity products, which does not require buyers to physically be at stores to test out the product through touch, smell, sound, taste or sight – take a shovel, bury it and stay as far away from it as much as possible.
Investing in a retail stock that has no foreseeable future is death by a thousand cuts. You will most likely be stuck into a value trap situation. Best is to be safe than to be sorry.
Books and games company such as Barnes & Noble, Game stop (GME) both had great balance sheet but are slowly withering off because they could no longer offer any of the 4 factors anymore to customers.
They have lost their relevancy to Amazon which spent billions of dollars building infrastructures to reduce cost and improve convenience.
Consumers who purchase a book or a game are mostly looking for the content of the product, not so much for how the book sounded, felt, smell and god forbid tasted like.
Both Barnes & Noble and Game Stop recorded a loss of -24million, 673million at 2018 respectively and also a decreasing amount of free cash flow including acquisition cost. And most probably it will stay that way.
So why bother spending more time and money on purchasing a physical cd when you can simply download it straight through the Internet? Why hassle yourself to think or carry which book to wherever you go when you can carry them all in your phone/kindle/ipad?
Examples of Application
Famous brands: Coca-Cola (Group 1, UP,US; Unique Product, Unique Service)
Value Proposition: Unique Product (Great taste), Convenient (Can purchase it in almost all Supermarket, fast food etc), Strong Brand Presence (Drinking this product gives you happiness, although more often than not, it can also give you diabetes).
Result: Coca-cola can often price their products higher than it’s competitors due to the three factors that they have. If you walk into giant or supermarket, take notice of Pepsi and why its always-on promotion, selling for $1 – 1.20 per 1.5 Litre bottle while coca-cola can always maintain their pricing power at $2 to $2.50.
What about those retailers who managed to turnaround successfully?
Old proposition compared to Amazon: Had no factors ever since the rise of online which caused the stock to reach an all time low of 12 dollars at 2012.
New Value Proposition: Unique Services, Geek squad – pay annual fee which a maintaince crew will fix any electronics for you at home for free), Price (Matching all prices online and reduce cost), Convenience (Turning stores into warehouses which increase available inventory, faster and cheaper shipping of product compared to online)
Result: Customers are coming back to the retailer, Revenue increasing at 4% per annum. Stock price from 12 dollars went up to 68 currently.
As we can see from Best Buy turn around, it is evident that retail is not 100% doomed to failure; consumer didn’t really care if it was online or offline. They care about value propositions.
Online and offline is just a tool to enhance convenience.
There is still a need for customers to try products at the site, for example testing out mattresses, a shoe, a perfume, a towel or clothes; Products that could not be felt, smell, tasted and heard.
Physical retailers have many options and advantages to play around against online such as:
- Changing part of the Physical store to Warehouse for easier shipment (Convenience)
- Changing supplier to low cost suppliers (Cost)
- Upgrading Website to improve usability (Convenience)
- Improve merchandising (Unique Services)
- Private Label Brands (Unique Product)
- Renegotiating with expensive landlord leases (Price)
- Omni Channel for both online and offline (Convenience)
- And many more options
Most retailers’ blessing and curse at the same time is when customers comes to a physical stores, wallet loaded with cash, to test out their products only to be purchasing it from their online competitors which offered the exact same thing at a cheaper price.
But fortunately enough if the business is in Group 1 or 2, it’s just a matter whether they have the finances to improve themselves so that they can achieve the factors I mentioned above.
But how do we see if they have a financial power to turn the tides? Lets find out!
Step 2 – Group 1 & 2 Businesses and Financial Capabilities
A great soldier cannot fight a war if he runs out of ammunition.
A company without good financial backings and dwindling customer proposition will risk filing for bankruptcy.
I know what you are thinking…
Yes, there are instances where some businesses are at the guillotine, ready for his head to be chopped off, only to be saved by an all worthy CEO in his gleaming white armour.
Just like how blockbuster Marvel, viewed by millions of fans globally, was being saved by Peter Cuneo, who only had bones and sticks to play with.
Stock wasn’t worth a penny back then, now it is sold to Disney for 54 dollars. A multi-hundred bagger investment!
But the truth is not many companies are like marvel. And most obviously we are not living in a fairy tale; a lot of company just vanish into thin air without people knowing.
The whole point about sticking to the process is to maximise Overall Profitability with Certainty.
3 pieces of paper, the Income Statement, Balance sheet and Cashflow Statement, will tell you a lot of story about the existence of business competitive advantage, durable competitive advantage, how management is thinking and allocating capital etc.
But to keep the article simple, we are going to focus more on the balance sheet and elaborate what are we looking out for a turnaround or undervalued stock.
Remember, the things I mentioned below are not a hard and fast rule, if one financial attribute is absent, perhaps other components can compensate for it. It’s like a jigsaw puzzle; we need to see the thing in a whole picture to roughly gauge the situation and not jump the gun.
The idea is the same as net-net graham play, Book value and CNAV 1/2. We want to purchase the stock at the lowest price with the highest value, to cover ourselves from our mistakes.
If we are “so unfortunate” that the company is going to declare bankruptcy at least we know we can still liquidate it at a slight gain – we might even want it to liquidate versus struggling and draining its assets.
High cash: Over surplus of cash is most of the time a good problem. Sometimes it might Signal that business is enjoying a durable competitive advantage. Sometimes it signal management does not have a clue how to allocate it. But with a healthy cash load means even if the current management is lousy, the new management will still be given a good hand over to turn the tide.
Low total debt: Check Debt maturity if it can repay its debt on time. If the company has a high short-term debt to total asset, it might also mean that they have the high cash flow to finance short term debt issuance. If there is a high amount of long term debt because it is a capital intensive company (bad) or is it because they have recently used it for operational purposes?
- Can Current Asset pay off Total liability (ie; Net Net)? (Good)
- Is there large repurchase of undervalued shares and / or undervalued bonds? (Good)
- Are there long-term assets (spin-off) to be sold off so that it will drastically increase the cash? (Good)
- Does it have a total asset less initangibles or goodwill to total liabilities of 2:1 respectively? (Good)
- Total asset minus goodwill and intangibles –> We do not have a clue what intangibles is worth so all goodwill and intangibles will be presumed to be worth 0 to protect ourselves from being too optimistic.
- Total assets for the retail industry are usually worth around 75% (we can and prob should adjust down to 50% to be extra conservative) during liquidation compared to unique product industry such as Oilrig Company or ford motors, which sells for way lesser at around 20% to 40% liquidation.
Income Statement & Cash flow
- Does it have negative earnings and cash flow and why?
- What are the 5 to 10 years earnings trend and average earnings?
- Is it because of negative goodwill initiatives, which make the earnings much lower than before?
- If operating cash flow and earnings are negative but you have a strong balance sheet. You have a ticking time bomb on your hand.
It is advisable to stay away from such situation unless you are superbly loaded and can buy over majority holdings to liquidate the company. Ala Buffett.
- Understand and find out about the 4 competitive advantages of the company (You can find competitive advantage by qualitative and financial report checking.)
- If it is under group 1 or 2, question if they have both financial strength and business viability to turn around. (Not all business with good financial strength can turn around.)
In the next article, we will talk about some specific stocks to explore, which have all I criteria I mentioned and also specific financial breakdowns to see if they can thrive.
Peace. Leave your comments below if any.