is it time to sample stocks in these two dog-eat-dog sectors?

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Two of the roughest, most failure-prone sectors in the stock market have always been—and probably always will be—restaurants and retail. Competition is brutal in both spaces, margins are usually slender, and bankruptcy always seems to be one poor management decision away.

I’ve written about the slow-motion train wreck of the traditional retail sector fairly regularly over the last couple of years, and with several large operators like Nordstrom’s and Kohl’s posting surprisingly decent earnings lately, I thought it might be a good time to check back again. Could brick-and-mortar retail be on the brink a comeback?

Probably not.

Last week, job placement firm Challenger, Gray & Christmas reported that 43,600 retail jobs have been eliminated since January. One iconic chain after another, including Sears, Penney’s, and Macy’s have announced store closings. Teen retailers Pacific Sportswear and Aeropostale filed for bankruptcy in April and May, respectively, while Sports Authority went under in March and closed all of its 460 stores by June. This creative destruction is likely to continue.  According to Mark Cohen, the director of retail studies at Columbia University, “the traditional retail industry in some respects is facing Armageddon.”

The one/two punch of ecommerce and Amazon has left most brick-and-mortar retailers reeling. Amazon reported 2015 revenues of $107 billion, and is expected to grow to $137 billion in 2016. Amazon’s stock is up 13 percent year-to-date, 2446 percent over the last ten years, and a stunning 50000 percent since its 1996 IPO. The only retailers left relatively unscathed in its wake are deep discount concepts TJ Maxx, Ross Stores, and Dollar General. These chains offer ‘treasure hunt’ bargains that Amazon does not/cannot offer. (Some specialty firms like Louisiana-based Pool Corp, which I mentioned a few months ago, are also faring well.) Even with these few bright spots, for John Q Public, buying retail stocks, however inexpensive they appear, is an extremely risky and probably ill-advised strategy.

Restaurants could be a different story, however. There is no Amazon equivalent devouring the sector. Also, restaurants are benefiting from a favorable secular tailwind as well-managed chain operators continue to expand their marketshare. Many folks might feel a nostalgic fondness for mom-and-pop diners and other locally-based eateries, but chains hire better people, train them better, buy food at lower prices and understand that good, consistent menu offerings are the key to financial success. While my fund does not own any restaurant stocks today, my reluctance is due to excessive valuations, not long-term viability. Shake Shack, The Habit, Wingstop, Buffalo Wild Wings and the still private Five Guys are all great concepts with great growth potential. I am less excited about Cheesecake Factory (they are great operators, but the food is mediocre), Noodles, Pot Belly, and Del Frisco.

Personally, I am fascinated by restaurants. Maybe it’s because performing due diligence on them is a lot more enjoyable than analyzing an obscure software or biotech company. I own 50 percent of a successful nine-year-old Cajun restaurant in Berkeley, California. I have also invested in other restaurants (with my own money) over the last two decades. Some have done quite well. Some have crashed and burned. Investing in restaurants can be fun, but nerve-racking, because it doesn’t take a Chipotle-level scandal to bring on a sudden reversal. Consumers often simply tire of a concept. In recent weeks the 48-unit Fox & Hound, 23-unit Champs, and larger chain Logan’s Roadhouse have all filed for bankruptcy. Houston-based Ignite restaurant group, which owns Joe’s Crab Shack and Brick House Bar and Grill, is teetering on the edge of bankruptcy, as well.

Perhaps the most intriguing trend in retail and restaurants is the blending of the two. Chains like Ralph Lauren and Oxford Industries have profitable restaurants that help promote their larger apparel efforts. I recently bought 40,000 shares in Oxford Industries after visiting with its management. I believe its biggest brand–-Tommy Bahama—could grow at a double-digit rate after disappointing first quarter results. The coconut shrimp on its menu are pretty tasty, too.


2 thoughts on “is it time to sample stocks in these two dog-eat-dog sectors?

  1. Pureum Kim

    Thank you for the great post. Personally, I am not comfortable with restaurant stocks. There are simply too many risks from bad weather, outbreaks, and simple bad luck. However, I would be happy to short them but I am still very new shorting.

    Reply

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