Bill Barker (TMF Max) sat down yesterday to discuss the retail industry with Fool analysts Brian Graney (TMF Panic), Bob Fredeen (TMF Boddog), Rick Munarriz (TMF Edible), and Lou Ann Lofton (TMF Lou2). In Industry Focus 2001, Brian Graney analyzed the home furnishings retailing sector, and Bob Fredeen looked at the athletic footware sector. The following is a transcript of their discussion.
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TMFBobdog: Considering all the bad news retailers have given us during the holiday season, I don't see a lot of good news on the horizon. I'm worried that the weakness we're seeing in retail now will translate into weak cash flows and less expansion next year. For retailers that have planned on lots of expansion next year, those plans will be hard to meet.
The athletic footwear industry, on the other hand, should be the most exciting it's been in years.
TMF Max: Well, it's been years since it's been exciting at all, as far as I can recall. What's different about 2001?
TMFBobdog: The biggest difference is, ironically, at the retail level. The footwear retailers, led by Venator (NYSE: Z), Footstar (NYSE: FTS), and Finish Line (Nasdaq: FINL) have done an excellent job of cleaning up their balance sheets over the last couple of years. They have closed stores, dumped inventory and paid down debt, which ultimately left them in a stronger position for 2001. Now that the retail end of the industry has a few less players, and the remaining players are stronger, they will be better able to put new and exciting shoes on the shelves. This is where Nike (NYSE: NKE), Reebok (NYSE: RBK), adidas (OTC: ADDDF), and all the rest of the marketing companies come into play.
Nike has just released the second of their "Shox" shoes, with a good amount of marketing support. Reebok is working on putting more women's shoes and re-focusing on their core strengths in running and aerobics, while emphasizing their technology. These two companies are, in my opinion, the key for success next year. They are starting to talk trash with each other, and really working on generating excitement.
TMF Max: It's funny that you should mention Footstar. As all of us know, but as probably few of our readers know, Footstar is sort of the prototypical company that we can write about and expect to get no reader interest. In fact Brian, you latched onto a Footstar story back in May, and since that point, Footstar's been a pretty awesome performer in a generally awful market. So what were you looking at then, Brian, and what are you looking at in retail now?
TMF Panic: You're right, Bill. Footstar is up about 30% to 40% from when I first looked at it earlier this summer. It was just featured as Fool Daily Double, in fact. Basically, a lot of the smaller retail chains that weren't part of the momentum crowd but which were still putting up respectable fundamentals got beat up over the past few years. We're starting to see that turnaround. Moreover, the smaller retailers in general have outperformed the big boys in 2000. That said, there is still quite a bit of value left in many areas of retailing. That includes forgotten-about areas like furniture retailing, which was the area I looked at in my Focus article.
TMF Max: So what metrics do you look at to determine the best furniture retailer(s). What are the fundamentals you look at first, and does that differ from other retailing areas?
TMF Panic: For the most part, furniture retailing is very different from other retailing pursuits. You can't turn your inventories as fast as, say, a Wal-Mart (NYSE: WMT) can turn boxes of Tide. So, cutting prices and trying to beat the other guy on volume doesn't work in furniture retailing.
The way the industry has shaken out in the past few years, investors have a choice between retail chains that are tied into a specific brand, such as Ethan Allen (NYSE: ETH) or Furniture Brands (NYSE: FBN) with its Thomasville line, or regional operators that know the communities they serve very well. That means investors should gravitate toward the better brands out there, while also paying attention to traditional retailing metrics such as same-store sales, operating margins, and expansion capital expenditures.
TMF Edible: Brian, Furniture.com is now dead. Is furniture something better suited for the physical showroom?
TMF Panic: No doubt about it, Rick. Selling furniture can be a logistical nightmare, both for the retailer and the end-customer alike. While the Internet definitely has its place in terms of making it easier for the customer to do their homework on the products before entering the showroom, I don't see how people would entrust such a large purchase to an online furniture site. I mean, would you purchase a couch without sitting on it first or feeling the upholstery? I know I wouldn't.
TMF Max: Hey, is anything going to work out for retailing online? Anybody?
TMF Edible: I think we're at the point now where no one is going to subsidize losses just for the sake of sales growth online. The "land grab" was built on a fault line. Thanks to shopbots like MySimon.com and coupon consolidators like DealCatcher.com it is hard to set yourself apart from anything beyond price. That is why I think the retailers with unique offerings, beyond the obvious commoditized items, will be the ones that have a shot at making the Internet work for its intended purpose. That is, a source of convenience -- not some cut-rate cyber flea market.
TMF Panic: Yeah, I'd agree with that. Most of the slam-dunk online retail opportunities have been exploited, especially in areas where there is what Peter Drucker has called a high value/low weight ratio. This would include books and CDs and the like. Still, I think there is something to be said for the Amazon.com (Nasdaq: AMZN) model and the idea of building online customer scale to such a degree that when an individual goes online to buy something -- anything at all -- he or she goes to Amazon first before anywhere else. So there are some branding, convenience, service, and reliability factors here.
TMFBobdog: I think Brian's mention of the reliability factor is key for long-term success online. We've passed the "Wow! I just bought a book without leaving the den!" stage of online retail. Online shopping isn't all that new and cool anymore. People want these companies to deliver, to do what they say they are going to do. Companies are still having trouble working out the fulfillment side of the business, and that is the key going forward. Cool marketing doesn't matter if you don't live up to your promises.
TMF Max: All of which makes the sectors you were looking at in Focus, Brian and Bob, that much more attractive. You've got real operating histories to look at there to measure. You're not in the land of the eToys (Nasdaq: ETYS) of the world -- and isn't that a terrifying thought? -- where you're "investing" in mostly pure speculation about the future of the company. Is that what you guys found attractive about the seemingly dull footware and furniture sectors?
TMF Edible: Dull? Venator, Footstar, and Reebok have more than doubled in recent months. Nike is almost there. Not that boring, is it Bob?
TMFBobdog: Not at all. That excitement is an important part of why I choose boring, low-tech shoes for Focus 2001. Things are starting to improve for the industry. Prices are going up, Nike is selling their newest Shox shoes at $150 while other companies are adding $10 here and $20 there to their prices. This is great for margins, which have been stagnant for a couple of years. Most importantly, the companies throughout the sector have really gotten their collective act together. They seem better focused on their brands and on their businesses, and that should result in a great run for the industry over the next couple of years.
TMF Edible: Definitely. Even with maxed out plastic and a teetering economy the consumer has spoken: We will not go into the next recession barefoot!
TMF Panic: Nor will we give up our couch potato habits!
TMF Edible: But, Brian, if the housing market suffers, will we still want that convertible love seat?
TMF Panic: Actually, it's interesting. I was reading a study recently that tracked shareholder returns for furniture companies against key macro-economic gauges such as new housing starts, and there was very little correlation. Sure, margins can come under pressure in the short-term under an economic slowdown and some folks will rein in their discretionary spending. But the best operators with the best brands keep chugging right along.
With so many bankruptcies in the industry over the past few years, a think the major furniture players have thought out how to react to a slowing economy and have already acted with a certain degree of fiscal restraint, at least as far as new store expansion goes. The best players have also deleveraged themselves when the times were good, similar to the trend Bob pointed out earlier in shoes.
TMF Max: Let me play John McLaughlin for a moment. Exit question. In 2001, is offline retailing more exciting, or less exciting to you guys than at the same point in time last year? And why?
TMF Panic: I think it's more interesting generally, especially since many of the big boys like Home Depot (NYSE: HD) and Gap (NYSE: GPS) have hit the skids late in the year. Lou's been following those developments. I'd be interested to hear what she has to say.
TMFLou2: This year for Gap's been painful to watch, and equally as painful for my portfolio, since I own the thing. Am I excited about next year's prospects for it? Actually, I am, though hesitantly so. After an ugly Q3, the company is making a little headway, but we still have to see how this holiday season plays out. Inventory management is key, and they have to figure out a way to get folks back into their older stores. November comps point to that becoming a reality which is encouraging. I'm holding, even in spite of the Rule Maker's sell.
TMFBobdog: Gap is in transition right now. They are working hard to fix a bunch of well-documented problems. They are putting together new marketing and design teams, trying to improve their products, and trying to get more customers in the door. Even with all of those problems, I think the company is making headway, like Lou said. Overall, I think Gap is still one of the best retailers out there, and just about the only one I would want to invest in for a long time. I'm with Lou on this one.
TMF Edible: I'm not. I've got one word for Gap: khaki-phony. But, getting back to McLaughlin's question, I think offline retailers will be in for an exciting 2001. For starters, it's the first time in years where "bricks-and-mortar" is not a dirty catch phrase. Given that, you still have 2001 as the first full year for the relaunched e-tail efforts of Walmart and Kmart's (NYSE: KM) Bluelight.com. But I think investors have realized that malls and suburban strip malls are NOT going out of business. Not unless they get Pets.com (Nasdaq: IPET) or Toysmart.com as tenants.
TMF Panic: Yeah, in fact even a mall operator like General Growth Properties (NYSE: GGP) has had a good year. Dull is in again.
TMF Max: Thanks all.
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