It’s no secret that the retail sector is evolving rapidly. It feels as though with every day that passes there is a day where the economy is drifting away from the “big box store” and towards the online shopping cart. Consumer spending still makes up more than two-thirds of the U.S. economy, but consumers’ spending habits (where and how we shop) are changing quickly. For investors, it makes sense to have retail/consumer discretionary exposure in portfolios. The question is: where to invest?

 

In today’s economy, investors need to examine how retailers are working to reshape the technology driving their businesses. In other words, how much is the company spending to create and/or update technology infrastructure, so they can reach consumers online and maintain market share in an increasingly competitive environment?

E-commerce (online shopping) in the U.S. accounted for 10.4% of retail sales last year, up from 9.3% in 2014 (according to Morgan Stanley). And that number is almost certainly set to continue rising. Who are the main drivers of this online shopping spree? You may have guessed it: Amazon.com. Amazon’s North America sales rose by nearly 30% in 2015, and sales have been brisk so far in 2016 (According to the Wall Street Journal).

Meanwhile, the classic brick and mortar “big box” retailers are struggling to keep up. Kohl’s, Macy’s and Nordstrom have all pared back earnings expectations for the year while announcing store closures in droves. In Q2, Nordstrom reported that sales at existing stores fell for the first time since 2009. In many cases, these retailers cited closing weaker locations so they can divert their spending to upgrading websites and enhance their delivery options. It’s a sensible strategy, but can they make the transition fast enough?

As of this writing, the picture looks bleak for the brick and mortars versus the online king (Amazon):

  • Macy’s Inc. – announced 100 store closures, stock is down over 35% in the last year
  • Gap Inc. – set to close 75 stores (mostly internationally), with the stock down over 26% over the last year
  • Kohl’s– announced 18 store closures earlier in the year, with the stock down over 17% in the last year
  • Nordstrom – announced 350-400 job cuts in 2016, with the stock down over 32% in the last year
  • Amazon.com Inc – digital sales of $99 billion in 2015, estimated to account for 19% of the U.S. apparel market by 2020. Shares are up over 43% over the last year. (According to Google Finance)

How to Stay Competitive: The Wal-Mart Approach

“If you can’t beat ‘em, buy ‘em.” This appears to be Wal-Mart’s response to the rapid shift to E-commerce. Last year, Wal-Mart’s digital sales totaled around $14 billion, a paltry comparison to Amazon’s $99 billion in sales (According to the Economist). What’s more, Wal-Mart’s quarterly online sales’ year-on-year growth has been decelerating over more than a year, even as it invested billions on expanding its digital operations. That is, until now.

Earlier this month, Wal-Mart announced a $3.3 billion acquisition of Jet.com, a 1-year old online retailer whose growth strategy puts emphasis on “savings.” Through Jet.com’s pricing schemes, customers are incentivized into bulk buying and purchasing products from the same distribution center, or the one nearer to the buyer’s location, thereby lowering logistical costs for Jet.com. Shoppers are also encouraged to pay using debit versus credit cards to economize on transaction fees, and customers are given the choice between free returns and a price discount at the checkout. It’s essentially Wal-Mart’s “everyday low prices” approach, online.

Wal-Mart acted with conviction (if not brashly), but it just may have bought them a ticket to the future of retail sales. The question is, can other retailers do the same?

Bottom Line for Investors

To expand sales online and survive in the 21st-century economy, retailers have to spend big on technology. The problem is that doing so can mean squeezing margins, and if a retailer finds themselves with squeezed margins and closing underperforming stores (which can send customers to online alternatives), its share price could suffer considerably. Many “big box” retailers have already seen this first hand.

For investors, this does not necessarily mean avoiding the brick and mortar retailers altogether—a turnaround is always possible, and a Wal-Mart-like savvy approach could work well for the company. The key is to examine the retailers’ technology and e-commerce strategy and assess whether it is enough to keep it competitive.

 

So what does this mean for your portfolio? One investing key is to make sure your portfolio is diversified to manage your risk/reward equation. With that, having retail discretionary exposure seems to be a savvy approach. But, the question still remains—where to invest? Our process at Zacks Investment Management brings Zacks Investment Research and our investment strategies to the individual’s portfolio. The result is five investments strategies ranked in the top 10% of their respective classes by Morningstar (as of 6/30/16).

To help you effectively evaluate your portfolio, download our Stock Market Outlook report. This report is an invaluable resource for any investor and our goal is to position you for future investing success.

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