“Our Fortress Balance Sheet:” VF’s June 30 Quarter

That’s how CEO Steve Rendle describes it in the quarter’s conference call.  We’ll quickly review the numbers, but in this maximum pandemic quarter, it’s not so much about the income statement as the strategy and management response.  We’ll let VF’s management explain to us what they did and how they were prepared.

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Some Interesting Things You Might Have Missed

Emerald Raised the Money

As I reported in June, Emerald Expositions was raising $400 million through a convertible, preferred stock offering.  Part of it was an offering to its stockholders with its majority owner, Onex, agreeing to take whatever part of the offering those smaller shareholders did not purchase.

I was skeptical in the article that shareholders other than Onex would participate in the offering.  Now we know.  In an 8-K filed on August 13th, Emerald tells us they “…sold a total of 71,446,346 shares of Series A Preferred Stock pursuant to the Investment Agreement and the rights offering, of which Onex purchased a total of 69,718,919 shares, including the shares purchased pursuant to the Backstop Sale.”  The deal is done.

Millennials Buying Old Houses

And why would you care?  Take a look at this article about them buying old, cheap, beat up houses that need a lot of work.  Any of you who have been through a significant remodel, especially with an old house (I’ve done both) are smiling, looking at the pictures of the houses in the article and thinking, “They have no idea what they’ve gotten themselves into.”  I can’t help flashing back to the 1986 Tom Hanks movie, “The Money Pit.

The point is they are going to make choices leaving them with less money and time for the things we’d like them to buy and do.  I’m not saying this is a problem you have to react to right now.  However, the evolution of generations through phases of life is a constant.  In the same way winter resorts are having to figure out what to do as the baby boomers aren’t going big anymore, we’re going to have to consider the changing needs and priorities of the millennials.

How Much Does It All Cost?

Robin Lewis wrote this excellent article on subscription models.  As a lead in, he quotes this first line from one of his earlier articles, ““Bring it to me, just for me, new, now & more often,” and I found myself thinking, “How much does this all cost?”

But that was the wrong question.  What I want to know is how your cost structure is going to evolve.  Forget the hopefully short-term costs associated with Covid 19.  When the working vaccine has been distributed (sooner rather than later would be nice), when social distancing and cleaning inefficiencies go away, when the supply chains are less disrupted where are you going to be spending money?

Consistent with Robin’s quote above, I expect you to be spending it on being flexible- in acquiring product, in moving it around, in getting it to and from the customer, in changing it based on customer expectations in collecting and managing data.  Other costs, such as advertising and promotion, I expect to decline.  You will also have had general and administrative costs decline as you resolve the issue of merging ecommerce and brick and mortar expenses in such a way that they are supportive rather than competitive.

If you don’t do that, well, you won’t have to worry about any other issues.  Ever.

While expenses may rise, I’m thinking that margins will rise as product quality is emphasized and as the overwhelming number of brands and retailers declines.  Completing that process probably requires a normalization of interest rates that is not in our immediate future.

That pandemic accelerated decline in the number of brands and retailers may start to restrain consumer dominance and return some balance to the relationship between consumer and brand/retailer.  At this point that’s sheer speculations on my part.

 

 

 

 

Having Your Stores Open When Others Don’t.  Is it a Long-Term Advantage?  Big 5’s June 28 Quarter

It’s the financial statements we’re seeing and will see in the next month or so that will begin to help us decide who might be long term winners and speculate on why.  I emphasize “speculate” because it’s too soon to reach conclusions.  But I begin to think that keeping the new customers you got when competitors were closed or went out of business will be an indicator of success.

Being Essential

In the quarter that ended June 28th, Big 5 Sporting Goods had revenue of $228 million, down just 5.4% from $241 million in last year’s quarter.  Gross margin rose from 30.34% to 31.67% while SG&A expense declined by 10.2% to $58.3 million from $73.1 million in last year’s quarter.

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Why is Hibbett Sports Doing so Well This Quarter?

On July 20, Hibbett Sports released a press release and held a conference call to update it’s expected quarterly results.  For their quarter ending July 31st, they forecast comparable stores sales to increase more than 70%.  First half comparable store sales are expected to be up 20%.

It’s great to have an industry retailer reporting those kinds of results.  It’s also good to ask how they did it and whether or not it can continue.

The first thing to know is that Hibbett kept its stores open when the virus hit “…where local authorities and our landlords deemed it prudent,” says President and CEO Mike Longo.   They have been able to open nearly all their stores, the press release tells us.

Take a look at this link to see how they managed their stores for safety while keeping them open.  It seems pretty comprehensive.  The only thing I was surprised not to see was a requirement for customers to wear masks.

Hibbett also notes that they have “…nearly 1,100 points of distribution in mid-tier population centers.  Only 20% of our stores are located in enclosed malls,” and that they are “…a small box retailer with fewer people concentrated in stores at any given time.”  I can see why that helped them decide to stay open.

I wonder if they had any outbreaks of the virus in any of their stores.

They don’t discuss how they communicated with their employees, what the process and timeline for making the changes that allowed them to remain open was, and what the employees’ response was like.  Probably glad to have their jobs and not quite aware (like all of us a couple of months ago) just how serious the virus was.  It would be important to hear how that all got managed in detail. It might say something about Hibbett’s ability to respond quickly in a time when that’s a critical skill.

CEO Longo states at the start of the press release, “Our resilient business model and dedicated team members are delivering on our commitment of superior customer service with a compelling merchandise assortment.”

He continues, “We believe our sales have been positively impacted by multiple factors, including pent-up consumer demand, temporary and permanent store closures by our competitors, and stimulus money. These circumstances yielded increased traffic to our stores and website and the opportunity for new customers to experience our trademark service. We expect that we will be able to retain many of these customers in the future.”

When they break down the 70% increase in comparable store sales, we learn it’s 60% brick and mortar and 200% digital.  Hibbett is touting their digital capabilities- which is interesting since in October, 2018 I wrote an article with the title “Hibbett Sports Inc: ‘At the end of the 2nd quarter of Fiscal 2018, we successfully launched our e-commerce website.’ Wait- What? That Can’t Be Right.”  It appears there has been some pretty significant progress in less than two years after an extremely late start.  I guess I’d better follow them more closely.

On the one hand, Hibbett is crediting their “resilient business model” with their success.  On the other, they acknowledge that the sales increases were favorably impacted by pent up demand, closing of competitors stores, and stimulus money.  There’s also an implication in their discussion of inventory they were able to get.  Perhaps other retailers initially cancelling their orders allowed Hibbett to find what they needed to support their increased sales.  Perhaps at better margins?

Did Hibbett make an inspired management decision to stay open?  Did they manage it superbly?  Or were they the beneficiary of some one-time events during a period of reduced competition?  I don’t know because I have no knowledge of their management process.

Here’s how we’re going to know.  In the press release they tell us, “We expect that over 25% of brick and mortar sales will be comprised of new customers and estimate that approximately 40% of our digital sales will also be attributed to new customers.”  The extent to which they retain those new customers will tell us a lot about whether Hibbett management is smart or lucky.  My sense it is takes some of both.

It’s almost a controlled laboratory experiment in the ability of a retailer carrying the same brands at more or less the same cost as many of its competitors to retain the loyalty of new customers.  It also may tell us something about how online and brick and mortar support, or don’t support, each other.  Other retailers with stores closed had big increases in digital.  Will new digital customers prove sticky when stores were not open?

Hibbett makes it clear in the conference call they know it’s both an opportunity and a challenge to retain these customers.

I’m not even sure how loyal customers are to brands anymore, much less to particular retailers.   I’m intrigued to watch this evolve.

Macroeconomics, Data Systems, Balance Sheets and a Changing Business Model

As I explained in an earlier article, my usual detailed analysis of company income statements and reports for quarters ending March through May went on hiatus.  It didn’t seem useful given the initial disruption caused by the virus and lockdown.  Not writing doesn’t mean I wasn’t reading.  In no particular order, I reviewed VF, The Buckle, Tilly’s, Abercrombie & Fitch, Zumiez, Hibbett Sports, Dicks, and Deckers.

Hey, it’s good to have something to do when you can’t go to a restaurant, theater, gym, store, vacation, golf course (thankfully ended) and are threatening to run out of house projects.

This article isn’t about any of the listed companies.  It’s about all of them.  There are certain commonalities, trends, and uncertainties we should (hopefully do) have top of mind as we take this epic journey that increasingly looks to be lasting a while.

To set the stage, please go read this article by John Mauldin, whom I have a lot of respect for.  You won’t like it- I don’t like it- but I’ve never thought it was my job to help you think happy thoughts.  John is telling you something important more succinctly than I could (and with better charts!).

The 10-Qs and 10-Ks all show better results if the reporting period ended earlier in the year.  No surprise.  The average, unweighted, year over year quarterly revenue decline was 27.6%.  Take out VF and Deckers, with March 31 quarters and revenue declines of 11% and 5%, and you get a decline of 34% for those with later ending quarters.

Each has a section in their filings on the impact of the virus and the actions they have taken.  They are almost interchangeable.  Drawing down credit lines, furloughing employees, protecting the health of employees and customers, negotiating with landlords (or just not paying rent), cancelling or reducing orders, and stopping share buybacks are common actions.

It’s a reaction to a set of unprecedented circumstances and a level of uncertainty nobody managing a business has ever experienced.  If you take the time to review the “Risk Factor” section of some of these filings, it will strike you that their significance has changed.  They are no longer statements of possibilities the lawyers required.  They now represent real issues impacting companies.

“We’re screwed if our supply chain was disrupted,” a common risk factor might have said, though in better legalese.  “Oh yeah, I guess, but that’s not going to happen,” you used to think.  Oh wait- it just did.  I don’t know where you shop for groceries, but at the local Fred Meyer, shelves aren’t as full as they used to be.  If the supply chains are allowed to adjust, they will.  But it will take time.

On the plus side, I guess, I’m getting some remarkable buys on wine that’s not being sold to restaurants.  Diane and I are actually converting the hall coat closet to wine storage.  Look, if you can’t go out as much, which do you need more- coats or wine?

Conference calls and conversations with managers told me of some pent-up demand and optimism from some industry companies as reopenings began.  Those were the days of the hoped-for V-shaped recovery.  That’s not happening.  I’ll say again that I expect this to be the worse recession since right after World War II.  And it is happening worldwide in a way no other recession ever has.

Those of you who think the virus caused the recession should know that the National Bureau of Economic Research, responsible for telling us when recessions start and stop, announced on June 9th that the recession began in February- before the virus took hold.  Meanwhile, I’m guessing you’ve noticed that it’s surged in many parts of the country.  Maybe we just got too comfortable with the virus being around, but I think even a modicum of national leadership might have kept this mess from getting quite so bad.

The last piece of bad news is that this recession has happened when debt around the world is at unprecedented levels and will continue to climb.  That’s important.  What the research shows is that the positive impact of more spending on GDP, when it’s funded by debt, is much lower when debt is already high.  If you’re interested in the overwhelming evidence this is accurate, go to this page and read the article at the top of the  list called “Quarterly Review and Outlook; 2nd Quarter 2020.”  It’s pretty short, but not an easy read.

Sorry for all the bad news.  Regular readers know I made the decision years ago to say what I thought the data supported, even when I knew it wouldn’t be popular.  Somebody has to.  As always, please feel free to tell me if you think I’m wrong.

In these circumstances then, what matter?

Your balance sheet and, yes, I know you know I was going to say that. I won’t spend any time on it except to say that a strong balance sheet is a critical determinant of your ability to be flexible and, bluntly, to just come out the other side of this.  Outlasting your competition as a strategic objective sounds harsh, but there you have it.

Data.  You need it, it better be good, and I hope you started upgrading systems and optimizing for flexible, algorithmic data collection long before now.  Your financial model is changing.  Not just some higher costs due to the virus, but different costs.  Customer behavior is changing (duh).  As a result, I’m fairly sure some of your KPIs (key performance indicators) are changing.

Let’s focus on inventory.  Yours and everybody else’s.  Remember what happened when The Sports Authority went belly up and the inventory from their 400 stores, was dumped on the market?  I’d expect this to be a lot worse.  It includes not only the inventory from companies going out of business, but those desperately trying to raise cash (which is pretty much everybody), and the product you didn’t take delivery of.  Meanwhile, for some unidentified period of time, demand for all that inventory has declined as people increase their savings and lose their jobs (partially offset by government programs, but we can’t pay people $30,000 a year to not work forever).

If you’ve got stable inventory from solid brands and a balance sheet that supports this, consider carrying it over until next year.  If you’ve got the balance sheet to do that.

We’ve all acknowledged that the virus is going to accelerate ongoing changes.  If the virus takes as long as I expect to be controlled, more of the changes that might have been temporary will become set in stone.  What are those changes?  I could list the ones we all already know.  It’s the ones I don’t know and haven’t imagined yet that worry me.

I was going to ask, “What kind of stores do you need and where?” but that’s the wrong question.  The right question- the only question- is “What is your customer’s behavior and how has it changed?” The customer doesn’t care about your distribution channels, your inventory levels, or your supply chain problems.  They only care about the convenience of getting what they want, when they want it, the way they want it.

If you agree and think I’m not too far off on my macroeconomic analysis, then consider the implications for the importance of data.

Now can we ask how many stores, what size and where?  Uh, well, except we can’t until we’ve got a handle on our inventory- how much is where, how is it selling in different stores, how quickly can we move it around, which stores are also distribution centers, how quickly can we replenish it and, ultimately how much of what do we really need?

Some of those are old questions that go back to when the first retailer opened the first store. But with those answered can we get back to where and how big stores should be?  Sorry, no.  We need good data on our online efforts and how customers interact with us online.  How do online and brick and mortar impact each other?  What is the impact of opening or closing a store on online sales?

I could go on.  There is an immediate and massive interdependence of functions that just didn’t happen in the past when things could move slower.  No that’s wrong- the interdependence always existed.  But the required speed of the response has accelerated and the granularity expanded.  You can/have to make more changes in many smaller things faster.  Your business has to become a dynamic programming model.   Bluntly, I don’t see a way to manage lacking high quality and evolving integrated data systems.  Once, having that kind of data was a competitive advantage.  Now it’s just a price of entry.

You’ll know you have it when the answers you get surprise you and provide new insight into customer behavior.  At the tip of the spear, as algorisms improve, expect your systems to tell you to make, or they make for you, adjustments that initially seem wrong, but that work.

Aside from letting you identify and serve your customers better, consider why this is important to what I think is your new business model. Most industry companies are going to take some revenue hit for some unknowable period of time.  If we go back to some forms of locking down, it will be worse.  It’s true that your online revenue will rise, but it won’t make up for the decline in brick and mortar.  Yes, I know there are exceptions.

Product costs in general will rise not just because of supply chain disruptions but because of inflation.  But not just yet.  This ongoing form of magic money creation, historically, has always led to inflation, but as long as the velocity of money keeps falling, we may escape it.  For a while.  I expect you will find yourself raising prices to hold margins.  Those wonderful new systems of yours are going to be critical for having the right inventory in the right place at the right time and holding those margins.

Many of your will start to optimize your supply chains for reliability rather than lowest cost.  Your customers won’t tolerate anything else.  This might be an opportunity to focus on higher quality product.  I recommend you consider it as a possible point of differentiation.

Meanwhile, at least initially, costs are going to rise especially in relation to revenues.  Protection against the virus costs money and will last for an unknown period of time.  Meanwhile, and hopefully also short term, closing and opening stores, and managing staffing has some costs.  Taxes are going to rise, though not this year.

There is a ballet going on (maybe mosh pit is a better analogy) between working at home, landlords and tenants and malls.  Who is going to work from where and pay what for how long?  And remember the macroeconomic impact, as malls lose stores, tenants want to pay less, and real estate owners have trouble making their loan payments and lenders have big loan losses.

Ultimately, this all works out after a historically difficult adjustment period.  Those of you with strong balance sheets, a solid brand, quality systems and knowledge of your customers can even expect to come out of this in a stronger position.

But it’s going to be a wild ride.  The time for more of the same is over.   It won’t work.  Take chances.  It’s less risky than not taking them.

As an afterthought, if you want to get some historical perspective on the political, social and economic situation we’re in, you might read the latest chapter of Ray Dalio’s book on empires and cycles.  Here’s the link.  It’s all happened before.

 

 

 

 

 

 

 

 

 

 

 

 

What A Top Epidemiologist Thinks.  Consider the Business Implications

A friend sent me this excellent interview with Dr. Michael T. Osterholm.  He’s not a medical doctor.  See his background here.  Seems pretty clear he’s worth listening to when it comes infectious diseases.  His objectivity and willingness to say what we don’t know impressed me.

I’m supposed to write about business stuff.  The interview may be personally valuable to you, but I liked it because it also suggests some parameters for thinking about your business strategies.

The fulcrum seems to be when and if we get a vaccine.  If we get an effective one, and we can distribute it quickly, and enough people are willing to take it, maybe we get out from under this in, let’s say, a lot of months.  If not, we’re probably looking at years.  In any event, he seems to believe we haven’t seen the worst yet (decide for yourselves).  The longer it lasts, the more the cultural changes and habits of our populations, which includes your customers, will become established.

Here’s the link to the article.

 

Emerald Raising $400 Million and OR Goes Digital.

On June 10 Emerald, the publicly traded company that runs trade shows including Surf Expo and Outdoor Retailer and owns Shop Eat Surf announced they were going to issue $400 million in convertible preferred stock.

Like every company in our industry, Emerald is impacted by the pandemic, and is seeing already existing trends in its trade show business accelerated.  I discussed that in April in this article and won’t repeat everything here.  I’m going to quote parts of the filing and press release describing the deal and comment on each quote.

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Here We Go Again: Some Socioeconomic Perspective

When 1928 ended, there were some concerns about margin and trade flows.  But mostly people seemed to think that 1929 would be another good year.  There had been a string of good years, and today there is some speculation that the Spanish flu pandemic of 1918 left the survivors with a “live for today” attitude that had some responsibility for the “Roaring 20s,” as the decade was called.

By the end of 1929, the stock market had crashed, but nobody was standing around screaming, “It’s the Great Depression!”  Then, like now, it wasn’t always clear what you were going to have to dinner that evening, much less what the world would be like in a year or two.

And then, like now, we tended to project the past into the future, and it never turns out exactly that way.

I’m not expecting another Great Depression.  The speed and magnitude of the Fed’s response, the social safety net, and the technologies we have to address the virus make this different from the 1930s.  But if it turns into the worst recession since World War II, I won’t be surprised.  In the Great Recession GDP, at the bottom, was down about 4% and we hit 10% unemployment for a month.  The consensus for this quarter’s decline in GDP is almost 9%.  I expect the unemployment rate to hit around 20% at the next announcement.

As humans, we like to explain why things happen.  I think it brings us comfort- maybe a sense that we have some control- when we can point to a cause.  So, we point to covid 19.  Obviously, it’s had and is having a huge, unanticipated (though not unanticipatable except as to timing) impact.

But ask yourself, what if the companies that loaded their balance sheets with debt to buy back stock (at what turned out to be high prices) had that cash in the bank (Boeing- $44 billion just to use one example) or had invested it in productive assets that were producing cash flow?  They could use that cash now.

What if the Fed hadn’t kept interest rates way too low for way too long, causing incredible misallocation of capital, forcing people seeking some kind of yield to invest in things they had no business being invested in and allowing companies that should have gone out of business to be financed no matter how much money they lost and making you compete with some of them?

What if our politicians (from both parties over decades) hadn’t been willing to give us stuff we wanted that didn’t improve productivity without paying for it?  What if they saw being elected as a sacred public service rather than a career (yeah, I know, I expect too much)?  What if we’d been willing to elect people who wouldn’t just do and say what they thought would get them and keep them elected?  That one’s on us.

The pandemic would still have been bad, but not as bad from an economic point of view.  Here we go again trying to resolve a crisis that’s been exacerbated by too much debt with more debt when we know that more and more debt has less and less impact on GDP growth.  For about the fourth time, may I recommend, This Time is Different: Eight Centuries of Financial Folly.

Meanwhile, here’s an article with a series of graphs from May 14 that highlight the declines in various retail sectors so far.  As I’m sure you already know, you’re not going to like the one on apparel or, well, any of them.  At least we’re not airlines.

But it’s always darkest right before the dawn.  I’m starting to read and hear about brands and retailers seeing some bounce in sales, though it’s hardly a “problem solved!” moment.  For our industry and economy, and for the world’s economy there’s no V shaped recovery in our future.

The biggest strategic unknown for all of us is the extent to which the virus reemerges as we open up.  I’m feeling a bit isolated myself.  While I don’t completely blame people for wanting to socialize, getting too close to too many people for too long when we have no national policy or ability to test and do contact tracing has the potential to put us right back where we were.

That’s my best medical opinion, worth what you’re paying for it.  What’s your plan if the virus surges again?

What behaviors in which groups of your customers will change, and how long do the pandemic and associated economic ills have to go on before those changes become permanent and new ones emerge?  My parents grew up in the Great Depression.  I’ve written about how it created some permanent behavioral changes in them.  The Great Recession did the same to a different generation and I’m thinking some of the changes will be permanent.  And now, just a decade later, it’s happening again.  Damn- is “hunkering down” a strategy?

Speaking of changing behaviors, I’ve always worked out, belonged to a gym, and participated in any sport that would have me.  The last couple of months have not been great for exercise.  Or haircuts.

I should point out that neither Diane or I have a job to lose, and we don’t have children at home.  So basically, we’re lucky.  Our problems seem trivial when we think about what’s going on.

But finally, I haven’t been able to stand it.  I’ve ordered some TRX exercise bands.  I’ve gotten an exercise ball, some weights, and a large floor mat.  Even when the gym opens, I can’t work out with a mask and I’m unclear how an environment with everybody flinging sweat around and panting can be made safe.  I’d rather be in the middle seat of a plane.  What do you think?  Once I get this set up, will I ever go back to a gym?  The ROI is actually going to be fabulous with no monthly gym fee.

What changes are you experiencing that you didn’t expect when this started?

I’m rereading a book called The Day the Bubble Burst: A Social History of the Wall Street Crash of 1929, published in 1979.  It’s tragically laughable to read about industrialists and bankers orchestrating a campaign to keep the Federal Reserve from raising interest rates, or that, in early 1929, “A recent survey showed that the 60,000 families at the top of the economic scale were worth the same in financial terms as the 25 million at the bottom; and the wealthy were steadily becoming wealthier. Income from dividends, under a series of tax cuts introduced by [Secretary of the Treasury] Mellon, had risen 65 percent in nine years.  Higher dividends [like buybacks increasing EPS?] attracted more investors.  Up went the market.”

Read it to realize how it’s all come around again, but also to better understand the socioeconomic environment in which you’re running your business.

Those of you with quality customer and inventory information, strong integration of brick and mortar with online and a solid balance sheet who have made the hard choices early will, if you want to try and make this into a positive, be better off than others.  I would be particularly focused on long term customers and perhaps the subset of those who have purchased from you while stores were closed.  In that subset, I’d be really, really interested in new customers.

This is not my usual article, but I thought some perspective on what might turn into the worse year for this country since 1862 might be useful, and even give you some hope.  We’ve been through things like this before.  Crises accelerate change.  And even though the faster the change happens the more people hate it the change also creates opportunities and gets us from the bad to the good place faster.

You’re stuck with it.  Embrace.  The next article is half written in my head and will be specific as to some actions you might think about.

Speaking of Things That Might Change:  Trade Shows and Emerald Expositions

When we do get through the virus and at least some of the economic disruption, I’m wondering what the trade show environment might look like.  It had already been changing and it seems pretty clear those changes are going to accelerate.

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Kathmandu Releases First Numbers Including Rip Curl

Kathmandu released its number for the six months ended January 31 and I’ve finally gotten through the statements.  Maybe the first thing you should do is go read what I wrote when Kathmandu acquired Rip Curl on October 31, 2019.  Here’s the link.  I thought the deal could work, but I was concerned by the lack of solid financial information and wasn’t quite sure the integration was likely to go as smoothly as they projected.  Then the virus hit.

Like I did with Zumiez, I want to focus on the world as it now exists- Not so much on the results for the six months Kathmandu is reporting.  What does that mean exactly?

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