The stock market continues to track a downward path -- the Dow and S&P 500 have already shed over 7% just two weeks into the New Year. This volatility has generated uncertainty in many sectors, as companies grapple with their own challenges and opportunities.
In the apparel industry, Under Armour(NYSE:UA) recently unveiled its new suite of connected fitness products at the Consumer Electronics Show, entering the fast-growing but competitive fitness wearables market. Not even a week later, however, an equity report from Morgan Stanley sent shares tumbling. The report highlighted weakness in women's apparel and footwear, two key areas of growth for this industry darling. And after a disastrous 2015, Macy's(NYSE:M) is enjoying some positive momentum as investors cheer efforts at the company to close underperforming stores and reduce expenses.
For coffee drinkers, Starbucks (NASDAQ:SBUX) CEO Howard Schultz has been focused on the company's growth trajectory in China. With just 2,000 stores in the world's most populous country, the company plans to expand its presence rapidly, while holding onto the values that have made the coffee chain so successful.
What can we expect from these companies in 2016?
A transcript follows the video.
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This podcast was recorded on Jan. 12, 2016.
Sean O'Reilly: Starbucks thinks China will be a bigger market than the U.S., [today] on this consumer goods edition of Industry Focus.
Greetings, Fools! Sean O'Reilly here at Fool headquarters in Alexandria, Virginia. It is Tuesday, Jan. 12, 2016, and joining me to chat global consumer brands is, as always, the recently off the market Vincent Shen. How's your week going, Vince?
Vincent Shen: Going well, Sean.
O'Reilly: So did you hear the cries of all the women when you got engaged, and it was like, "Oh he's off the market and taken. Oh no!"
Shen: Sure. Yes. Absolutely.
O'Reilly: I'm trying to build you up, man (laughs). Fine. Anyway, we're talking Starbucks, and they updated their Chinese expansion plans. But first we're going to be chatting about Under Armour and Macy's. Now, as I'm sure you ... you totally listen to Dylan and I's tech show over the weekend, right?
Shen: I do. So I can make fun of it as much as I can, yes.
O'Reilly: That's wonderful. Feel free. Dylan and I chatted about Under Armour on the tech show last Friday, but it was mostly in a positive light because of their showing at CES and their rollouts of, you know, Fibit competitors and all that stuff. But unfortunately you and I have to chat about Under Armour in more of a negative light, because of recent events. So, what happened yesterday?
Shen: Yeah, absolutely. I think it's really funny because, like you mentioned, last week you and Dylan were talking about how the company (I'm sure) spent countless hours and a ton of effort preparing this big launch for themselves at CES of this suite of products they're offering.
O'Reilly: And it was a hit.
Shen: $400, you get the scale, the chest band, other wearables ...
O'Reilly: A heart monitor that's actually by your heart and not on your wrist (laughs) ...
Shen: Yeah, exactly. A whole fitness suite, essentially. That generated quite a bit of buzz at the event. But then they start this new week on Monday with Morgan Stanley their equity research analyst, putting out this very bearish report on the company, cutting it to a sell, essentially, reducing the price target some 40%.
O'Reilly: What is it, so that's like $40 or something? Or $50?
Shen: Yeah, it was reducing it significantly to about $62 -- I think below even where it's trading now.
O'Reilly: I might be getting ahead of ourselves here. Did they talk about valuation at all? Because that stock has a high P/E, like it always does, so ...
Shen: There's no denying that. Right now in terms of forward earnings I think it's trading about 51 times. Definitely high valuation. You have to keep in mind, the stock gained 19% in 2015.
O'Reilly: Not bad, yeah.
Shen: And that's on top of gains that it has put up ... it has logged strong gains -- double-digits I'm pretty sure for most years -- since 2009. Seven straight years of gains at this point.
O'Reilly: So what do those reports say? Because Morgan Stanley comes out, are they just being negative just to be negative? What's the deal?
Shen: Sure thing. I think there's two main points in the report that I want to cover and get to. I think in this case, sometimes these reports come out, they ding the stock, and it's not really something that's fundamental to the business. It's more of a near-term volatility. This is an instance where I actually do think it touches on very important issues for this company. If you think about Under Armour and what they've mentioned as being some of their pillars of growth: women's apparel, men's apparel, their international business, e-commerce, things along those lines ...
O'Reilly: Shoes ...
Shen: Women's apparel's been a big part for them. It's been growing very, very quickly, far outpacing their men's division. And the company has invested a lot to develop that part of their business. 2014 to 2015 I think they spent something like $15 million on the marketing campaign with some really famous athletes. The one that I remember seeing and thinking was really cool was with Misty Copeland, and she has her narrating over the video about how people were doubting her and showing her ... and also Giselle Bundchen had her commercial with Under Armour as well.
So a lot of buzz around that, and it was part of their efforts to build up their women's business. And now you have this report coming out saying, growth has gone from double digits essentially to stalling for the last six months of 2015. Stalling to essentially flat for the women's business, which makes up about a third of their total business at the moment.
And also the fact that ... The second issue to really ding them is how for their footwear they've seen average selling prices fall since the beginning of 2013, so about the past three years. Average selling prices for their running shoes have fallen 20%, versus 4% for the broader industry. The two ways that this rolls in, like I said, women's apparel being really important, but also in terms of the company's overall brand image ... It's always been high performance at a premium. High quality at a premium.
But with those average selling prices there's concerns now among investors that all of a sudden if there's this shift where the company must compete more on price, you're going to see ... obviously margins are going to start compressing, the average selling price is going to continue to fall. What impact that's going to have on their growth rate, which a lot of analysts are expecting to grow 20% to 25% annually over the next five years. Is that sustainable?
And so it really changes all of a sudden the trajectory that this company might take. It's an interesting look into this report, how it touches on two really important things for them.
O'Reilly: So, I got to be honest with you. I see analyst notes come out all the time for stocks. Sometimes they move, sometimes they don't. Do you agree with the stuff, like, how serious is this?
Shen: Okay, yeah. I think it's important to mention for the listeners too. Based off of that report being the main driver, the stock traded down 6.7% yesterday.
O'Reilly: So the market's clearly taking this seriously.
Shen: Exactly. And it's brought the stock's current year-to-date decline to about 13.2%, I think?
O'Reilly: This hasn't been the best year for the stock market so far, so we'll give them ... (laughs)
Shen: (Laughs) we're only 12 days in; I know it's early. But just to give you an idea. Another thing is, this is part of an ongoing trend, where shares have already fallen about 30% from their highs from September-October 2015. So keep that in mind. Also, the Morgan Stanley analysts drew from the SportScan data, that has shown that obviously a lot of that growth that exceeded men's apparel has flattened out.
But also the management itself, or the CEO, Kevin Plank has also mentioned that, "That is a really huge opportunity for us." He's mentioned how the company wants to change their in-store experience. He had a quote from another investor call where he basically said, "Our in-store experience for women who are shopping is not where it should be right now. It's not designed in a way to appeal to them as much as our male shoppers." And that's something that they are focused on.
So when you have management that's obviously spending money on marketing and spending money on the in-store experience to cater more to women shoppers, but the results come out with the growth basically nosediving down from previous levels ... I think that's a big part of the concern that drived that bearish trading yesterday.
O'Reilly: I had a crazy thought. It almost seems like Under Armour should buy Lululemon or something.
Shen: It's an idea.
O'Reilly: Could be a cool move. I don't know.
Shen: They're often cited as an example, like a proxy of the opportunity that's there. Obviously they appeal far more to ... they also cater more so to female shoppers. And they've shown that that premium model can work. Not that they haven't had their own challenges.
O'Reilly: Well and they're trying to build up their men's business. Have you been in a Lululemon store lately?
O'Reilly: It's like they're trying to sell me $80 shirts.
Shen: They're flipped, exactly. So it's almost like they're on opposite sides of that issue. But combining that with the footwear, which right now ... that falling average selling price I think had specifically with their running shoes. But if that spreads to, for example, their basketball sneakers, where they've also again been spending tons of money on some of these endorsement deals with big athletes, what impact is that going to have on that longer term growth?
O'Reilly: Cool. All right, well before we move on I wanted to point our listeners to the newly redesigned focus.fool.com. There you'll discover a special offer to join the Motley Fool Stock Advisor newsletter to start your year off Foolishly. All loyal IF listeners have access to a special discount on Stock Advisor that works out to $129 for a full two-year subscription. Just go to focus.fool.com to take advantage of this offer. Once again that is focus.fool.com.
So now we're talking about my favorite retail brand and yours, Macy's. They just announced a bunch of store closings. What was it, 40?
Shen: Yes. Store closings and layoffs. So we mentioned, Under Armour had a pretty good year -- I think up 19%, like we said.
O'Reilly: Macy's not so much.
Shen: Macy's has been struggling a little bit more. I have this down here where ...
O'Reilly: And they're not, just for listeners that may or may not be aware, they're not an outlier here. Nordstrom, Dillard's ... they all had a rough second half of last year.
Shen: Absolutely. So stock was down 47% in 2015, and pretty much all of that decline came after July. So the stock peaked around $73 and it's trading at about half that now. And the most recent announcement that from what I've seen has actually pushed the stock up quite a bit year to date is around those store closings that you mentioned, about forty stores.
Four of them, they were already closed last year. Thirty-six that will be closed through the spring of this year. Some of those are local. They include stores around Chesapeake, Glen Allen, Norfolk, Richmond, Virginia ... and they're hoping, along with the store closings and the layoffs ... they're laying off about 4,350 employees. That includes 3,000 sales associates, so about three to four sales associates per Macy's and Bloomingdale's location that they currently have. And then another 1,350 back-office service center employees. And even in terms of the senior management, they're giving 165 senior executives a "voluntary separation opportunity." So all that's going to add up ...
O'Reilly: Is that like "conscious uncoupling?" (Laughs) What is that?
Shen: So I think overall that's going to add up for a big part of that in terms of their expense reduction, which is going to be a big focus for them this year.
O'Reilly: Well not only that, but their average sales per store will automatically go up. No offense to any of these stores, but they're not closing the New York or the Tyson's Corner Macy's, or the ... It's in like Buffalo, New York ... Actually we're losing one in Hagerstown, Maryland, up here in the DC metro area. There's one in Akron, Ohio, at the Chapel Hill mall that's very close to where I grew up. They're not closing major stores. What they're trying to do is pivot to a mix ... And we're maybe getting ahead of ourselves here, but I love this move because they're pivoting through having these huge Amazon-like distribution centers for online sales. If you want to go shopping, you can find a Macy's, but it's going to be in a higher-density urban area, and they'll just mail it to you I guess, I don't know.
Shen: I'm glad you mentioned that. You're absolutely right. These store closings are obviously going to be of their lower-performing locations. They actually specifically say that the 40 stores will account for about $375 million in annual revenue. Keep in mind that their annual revenue overall is $27 billion to $28 billion. Drop in the bucket. Also keep in mind that ... They're hoping that $375 million doesn't just completely poof and go off, because some of those sales that might have happened at those locations will be diverted to nearby stores, for example. And also through their online efforts. Macy's now has really focused on their omnichannel strategy, about making the shopping experience attractive for somebody who's online, picking up in store, or actually going to the store to shop.
O'Reilly: It's just a good move, because that's inventory they don't have in these lower-performing stores ... It's a good move.
Shen: Another thing I think that's driving a lot of this is the fact that for at least as of their most recently reported quarter, trailing ...
O'Reilly: That was actually the ...
Shen: Their earnings [are] down to 2012 levels. They also have reported ... Two press releases actually came out last week. One for the store closings, some of the layoffs. But also around their holiday sales, which really came in weak. They were expecting for the obviously very important November and December months sales to fall by maybe 2% to 3%. They actually came in at comparable stores down 4.7% for the holiday season. So really hurting there. And also the fact that this warm weather that everybody's been talking about hurting apparel retailers, the fact that Macy's and Bloomingdale's they have a lot of representation in the regions that were hit with the really warm weather ...
O'Reilly: Do you buy that? Because if it's warm outside I'm more likely to leave my house, but on the other hand I'm not going to buy a jacket.
Shen: You're not buying a jacket, you're not buying your sweater, your scarves, your gloves ... All things that a lot of these retailers including Macy's, including Bloomingdale's ...
O'Reilly: They count on, because it's a $200 jacket.
Shen: They're counting on, exactly. Also the fact that the value of the U.S. dollar is still hurting their spending among tourists, who will go to some of their flagship locations, like you mentioned in New York for example.
O'Reilly: And then they'll spend less or something.
Shen: Exactly. So keeping all that in mind, we mentioned the $375 million of revenue they'll be losing as a result of closing the stores. But they're also really focused ... Those layoffs, like we mentioned, the $400 million ... Is going to generate about $400 million of reductions to the SG&A expenses. Really big for them, again, to reduce those expenses for them to get that net income number higher, since it has fallen to those 2012 levels.
Ultimately the company says, on a brighter note in terms of the holiday season, they mentioned that they had seventeen million online orders at their Macy's and Bloomingdale's websites during the holidays. So that's up 25% from their previous year.
Shen: So some progress where they're focused, right? And also, the stock's at $38 per share. It's up about 10% year to date, I think, on some of this news that people think is really important to push the company into a new era. But it's really a bargain right now.
O'Reilly: It's so cheap.
Shen: You and I were talking about this before the show. It's trading at 10 times forward earnings, and there's a 4% yield on the shares. That's pretty ...
O'Reilly: The P/E in the S&P, last I checked -- the S&P 500 Index right now, so the average 500 largest corporations right now in America -- is like 20. This is ... And they're still expected to grow through the end of the decade, last I checked.
Shen: Yeah, so the growth rates are definitely low, maybe low single digits. But the fact of the matter is, this is Macy's. This is Bloomingdale's. Very strong bellwether names in the apparel industry. Yes, they're having their struggles, but you can't honestly expect that as they close some of their weaker locations, that this weather's going to last forever. That the dollar's going to be trading like this even forever. So long term, this seems like a really, really solid place to jump in right now and just watch the stock as they hopefully are able to execute their recovery and their new growth plan.
O'Reilly: Awesome. So the story of the day, we've been promising it for about fifteen minutes now. Starbucks recently ... Actually today, correct me.
Shen: Yeah, I think it was ...
O'Reilly: Today or yesterday ...
Shen: Recent news, sure.
O'Reilly: ... Came out with their updated Chinese expansion plans, and [they're] quite large.
Shen: CEO Howard Schultz, he recently spoke with the Wall Street Journal, basically reconfirming his excitement and the opportunities that he sees in China. On the one hand you have the broad markets really worried about China right now. Manufacturing's down, the stock market's been really tumultuous there. They've had their circuit breaker ...
O'Reilly: Trigger like eight times, and now they're just not using it. Which I think is a self-fulfilling prophecy, by the way. If the stock market's down 3.5% and you know that there's a 7% circuit breaker, everybody's just going to sell down to the 7% thinking that it's going to happen anyway. It's a self-fulfilling ... Anyway.
Shen: So the really volatile stock market, and the thing is there's only 2,000 Starbucks in China. That's a recent milestone that they hit.
O'Reilly: What is there, 10,000 here? Did you catch that?
Shen: Keep in mind, the U.S. itself has 12,500 locations.
O'Reilly: I was the closest without going over, by Price Is Right rules.
Shen: (Laughs) and their growth plan right now is about 500 additional locations in China per year for the next five years.
O'Reilly: So that's 125% store growth in China by 2021?
Shen: I think the actual target is something ... They have 2,000 stores now; the target is ultimately to hit like 3,400 locations by 2019 or something along those lines.
O'Reilly: Oh my gosh.
Shen: Just to piggy back on that growth projection is, fourth-quarter revenue for the China/Asia Pacific segment more than doubled year over year to $650 million.
O'Reilly: And they don't break out China.
Shen: They don't break out China specifically, but when you're looking at that overall segment ...
O'Reilly: But it's the biggest market there, so ...
Shen: Exactly. Euromonitor International had some really interesting data around coffee consumption, for example, that I think supports Shultz's enthusiasm for this opportunity. China currently consuming about 4.5 billion cups of coffee a year. North America's at 134 billion cups.
O'Reilly: Oh my gosh. And China has 4 times the population, so ...
Shen: This is a big explosion for them, just because you're going from traditionally a tea drinking culture and now coffee's really taking off. But this is a place where the cups are selling ... They're not selling at reduced prices. We're talking about $5 a cup still for coffee in this market. Big opportunity.
O'Reilly: What's the GDP per capita these days? Because it's ...
Shen: I'm not really sure ...
O'Reilly: ... 35 here; I think it's like 10 or 12 in China. But obviously there's a huge variance, so ...
Shen: Another thing that bolsters the opportunity is, Chinese coffee consumption from Euromonitor, they expect it to rise 18% annually through 2019. Just to give you some context, the U.S. is at 1%. So not even close. Far, far outpacing that. I think, looking at this from the perspective of the reputation too that Starbucks has developed in China, it's really incredible. They've been voted best employer in China for several years running.
O'Reilly: I was going to say, the ways their health insurance benefits, if you work 20 or 30 hours ... I think it's 30 ... I would think that their hourly rate and their benefits would be really attractive in a lot of ways. Because it's attractive here, so ...
Shen: They have two new initiatives I think that are furthering the company's desire to develop this community-focused, employee-focused image that they have. There's one thing I felt was really cool. They recently had their Partner Family Forum in Chengdu. This is basically an opportunity for employees and their families, because there's a really strong family focus there in that market, to come and speak with the company and learn about why working at Starbucks can be such a great experience. And they're offering a subsidy now to full-time baristas and shift supervisors. They'll cover about half their housing costs. The idea [is] to help people who are starting their careers to pursue education or other opportunities, right?
O'Reilly: That helps in fast-booming cities where rents are crazy and a lot of stuff too.
Shen: They have about 30,000 employees now. This will cover about a third of them, so pretty substantial. And then another new initiative that they launched is called the Career Coffee Break. So if you have been working with them for 10 consecutive years or more, you can take 12 months' sabbatical and then be guaranteed a position when you come back that's the same or at least has the same pay and benefits. So you can take that year off to travel or spend time with your family. Again, reinforcing that image that they have.
In terms of the stock itself, it did fantastic in 2015. Up 46%. I think that contributes to the fact that they're trading about 31 times forward earnings now. So a little bit higher.
O'Reilly: Oh how I wish I had bought them in the financial crisis. You realize how low they got?
Shen: Yes, they were very very low.
O'Reilly: It was like $8 or something.
Shen: People seemed to think at the time that nobody's going to pay that much for their coffee anymore, obviously.
O'Reilly: It's like Howard Schultz said one time, he's like, "People are willing to pay a high price for a really concentrated cup of caffeine."
Shen: Expected annual earnings growth of 18% over the next five years to pay a 1.4% dividend yield. Plus I think this opportunity here with Schultz in a sense doubling down on China is ... He has proven time and again that he has the vision. They brought him back, and he has been a huge part of the Starbucks success. I think that focusing on China despite the fears people have -- it's the right idea.
O'Reilly: Awesome. Cool! Well thank you for your thoughts Vince, as always. We'll see you next week.
And if you're a loyal listener and have questions or comments, we would love to hear from you. Just email us at firstname.lastname@example.org. Again, that's email@example.com. As always, people on this program may have interests in the stocks they talk about. The Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell anything based solely on what you hear on this program.
For Vincent Shen, I'm Sean O'Reilly, thanks for listening and Fool on!
Sean O'Reilly has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon.com, Lululemon Athletica, Starbucks, and Under Armour. The Motley Fool recommends Nordstrom. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.