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Why Retailers Are Spending More

In this episode of MarketFoolery, Chris Hill and Motley Fool analyst Ron Gross discuss all things retail. They talk about a home improvement company, a consumer apparel company, and a supermarket chain. They talk about balance sheets, COVID-related costs, and much more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

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This video was recorded on May 20, 2020.

Chris Hill: It's Wednesday, May 20th. Welcome to MarketFoolery. I'm Chris Hill, and joining me is Mr. Ron Gross. Good to see you, my friend.

Ron Gross: Good to see you, Mr. Chris Hill.

Hill: This is going to be a retail show. This is all retail today. We've got Lowe's (NYSE: LOW), we've got the latest results from Urban Outfitters (NASDAQ: URBN), which I have some questions about, but we're going to start with Target (NYSE: TGT). And, you know, Target's story is similar to what we saw with Walmart (NYSE: WMT). Same-store sales up nearly 11% for Target; profits and revenue look good, but it all came at a cost, because Target is spending a lot more money.

Gross: Yes. As we saw with Walmart, but you know what, it's nice when most of your competition has been closed. And unfortunately, the circumstances are quite sad, but there weren't many places to go if it wasn't Walmart, Target, Costco, a few other folks, and the results show that, especially online. With online sales up a 141% for Target that's versus 74% for Walmart, but a different base they're working off of.

Interestingly and importantly, same-day services for Target up 278%, so whether you want same-day delivery or curbside pickup in the stores, they've, kind of, really got that locked down, they figured out over the last couple of years, by spending a fair amount of money, how to do that right. And this was the perfect time to be able to do that for consumers.

Store comps, in and of itself, perfectly fine, up 0.9%, but then when you add in digital, that's where you get that 10.8% comp increase that you're talking about, and that's versus a 10% comp increase for Walmart, so even a little bit better for Target. Average basket was up 12.5%, which led to an overall increase in revenue of about 11%.

But then there's the story of expenses. As you mentioned, $500 million spent on safety measures, higher wages, obviously, takes a chunk out of operating margins. And in fact, the product mix as well, there's a lot of lower-margin products, food, for example, being purchased, higher margin products, like apparel, relatively weak. So, $500 million spent on COVID-related expenses. Walmart, you'll recall, spent about $900 million on COVID expenses.

So, at the end of the day, profits were poor and they couldn't really make up for the fact that we were living in unprecedented times, but still, overall, you can't complain with these results during a pandemic.

As with all these companies, no guidance was offered and I didn't expect any. But I think they're seeing continued strength into April and May carry through, and in fact, across departments. For example, we thought apparel was weak, but we see some revival in more than just, kind of, the staples that these companies sell. So, probably, I would imagine, the rest of this year looks pretty good.

Hill: Yeah, we were talking the other day about -- you go back a few years and Brian Cornell, the CEO of Target decides, we don't want to be in the pharmacy business anymore, and so they sell that to CVS. And one of the things Cornell said at the time was, we're going to focus on things like home furnishings, home goods and apparel. And I think, fairly, there were some people who were skeptical about that.

You know, Cornell has had a very good track record as the CEO of Target. And may be skeptical is overstated, they basically just had some questions, it's like, OK, now you've got nearly $2 billion [laughs] from CVS, how are you going to spend it? And I think that, at a time when you have to look at, particularly, when it comes to men's suits, like, you would not want to be in that business, I actually think this is an opportunity for Target for what they're doing with men's and women's, sort of, casual apparel.

Gross: Yeah, they sell fine apparel at a good price. And it'll be interesting to watch, because we keep talking about all these retailers that are just not going to come back; there's going to be a fair shake out. And it'll be interesting to see, specifically in apparel, what happens there. Because higher-end people, who are looking for more expensive higher-end, I don't think are going to abandon their stores and start shopping at Target, certainly not exclusively, perhaps for weekend clothes, workout clothes, sweats, jeans, perhaps, but not for the higher-end stuff.

So, some of the higher-end stuff will survive, does that mean department stores have a place in that or is it going to be more boutiques? I don't have an answer to that yet; we'll keep an eye on it. But certainly, Target's done a fine job in that, kind of, mid-priced, fine quality, good value apparel market.

Hill: One of the things you mentioned was the average ticket price in this quarter. I think that's going to be something worth watching, certainly, next quarter and the one after that, because Target is one of those places, and it's not the only one that's like this, but, look, there's something to impulse buying. There is something to the idea that I'm going into Target, I've got my list of things, but as I'm walking around this large store, I see something here, I see something there. And it's like, and that sort of boosts up. I wonder if that's going to continue. You know, that seems like it's easier to control your [laughs] impulses if you're shopping online rather than just walking to the store. And I think the average ticket is going to be worth watching over the next couple of quarters, and what management says about it regardless of which direction it goes in?

Gross: That's a good point. I'm going to see if this hoarder mentality continues. Now, I had it in the first place, so I had it way before this. I would walk through a Target and I would leave with, like, six deodorants because I like just having backup in my cabinet, just makes me feel good because I'm a weird guy. But now, hoarding was like a real thing, everyone wanted backup because who knew when it was going to be available again; you know, whether it's toilet paper or whatever you're talking about. It'll be interesting to see if that follows through, if people continue with, "You know what, I'm getting one deodorant, but you know maybe I'll just get three this time around, and I won't have to come back any time soon." So, maybe the number of times you shop will be lower, but the average ticket will be higher. Those will be interesting things to watch, see how they shake out.

Hill: Let's move on to Lowe's and Lowe's had a really good first quarter. Revenue was good, same-store sales up just over 11%, but similar to what we saw with Home Depot (NYSE: HD)yesterday. Lowe's is spending more money on employee wages, benefits and, obviously, cleaning the stores.

Gross: Correct. And they had to, just similar to Target, similar to Walmart, similar to Home Depot as you said. $340 million, $350 million in COVID-related expenses for Lowe's. It's a necessity. You got to pay the associates. They, very kindly, help support healthcare workers and first responders as well with some of their cash, which is great to see.

But as you say, business was pretty strong with U.S. comp sales up 12.3%; that's a really nice number. Online up 80%; perhaps Lowe's is not traditionally a company you think of when it comes to online shopping, but we're all sitting at home doing some online shopping and they benefited from it for sure. Adjusted EPS, Earnings Per Share, up 45%. So, again, really, really strong numbers.

Now, they took some steps to shore up their balance sheet, as we're seeing across the board, makes perfect sense. There is $4 billion in senior secured notes, they increased their revolving credit facility by almost $1 billion, about $0.75 billion. So, now they have about $6 billion in cash, plus $3 billion of capacity on their revolver, should leave plenty of cash to, both, get them through where we are right now as well to make investments as needed.

They did suspend their share repurchase program, as has basically everyone. And again, they offered no guidance, which wasn't expected. But a really nice quarter for Lowe's. And they're spending like everyone. You know, Home Depot $850 million in spending versus Lowe's at $340 million, different size businesses. But you got to do what you got to do and it was a nice quarter.

Hill: It was. And, you know, we talked about this yesterday with respect to Home Depot. I mean, Lowe's is also one of those businesses that is very consistent in their ad spend. You know, they're not really, even though they have different promotions throughout the year, they're not really heavily dependent on one season versus the next. And I do think that Home Depot and Lowe's are set up for a pretty good run here in terms of their businesses because people are in their homes, they're looking around, [laughs] and saying, "I've got the time, what do I want to change, what do I want to do with my outdoors?" All that sort of thing.

But, of course, as you said, it's got to be balanced. I mean, you know, under normal times you'd say, "Well, gosh! This is a great opportunity; I'm going to just pick up a few shares of both," but as you said, Ron, you got to factor in the additional spending. I mean, they're being smart about it. I think Marvin Ellison, who's been CEO for just about two years now, he and his team are being smart with what they're doing at Lowe's.

But you can't just assume, because people are going to be spending more on the outsides of their homes that it's automatically going to flow to the bottom-line.

Gross: That's true, but I do think -- what you said originally is correct, and I think things look pretty good here. I think the interest rate environment is right, I think what people are spending on bodes well for both of these companies, stocks have held up very well relative. Lowe's is about flat for the year; Home Depot up about 9% or so. So, you know, it hasn't really taken as much of a hit as the market has, although, obviously, the market [laughs] has come screaming back to where we are right now, which is not that bad from a year-to-date perspective.

You know, the tale of these two companies is always, Lowe's is a little bit cheaper relative to Home Depot, Home Depot is a little bit more well-run than Lowe's. Both are fine companies to own. You can get Lowe's at 19X; you got to pay 23X for Home Depot. That disparity may be worth it, because Home Depot, I think, is a bit better-run.

But you don't really have to pick-and-choose, you could own [laughs] both of these companies. And I think you'll probably do pretty well.

Hill: Do you have a preference between these two? My only preference is Home Depot, simply by virtue of geography. The closest Home Depot is closer to my home than the closest Lowe's.

Gross: 100%, and that's exactly [laughs] what I was going to say. Now, I'm a Home Depot shareholder, so from that perspective, I have a preference, but as far as shopping goes, well, first of all, it's not my preferred place to shop, I'm not that handy, [laughs] for lack of a better word, but if I got to go, it's whichever is closest, and that happens to be Home Depot.

Hill: I'm not handy either, but that's one of the things I like about Home Depot. And the few times I've been to Lowe's, I've found the same experience that they got staff that's going to help people like you and me. Because typically my move at Home Depot, is I walk in with, like, the thing that I need and I'm just holding it up, I'm just wandering around, like, go up to someone in an orange apron, I'm like, "I'm looking for this, I'm looking for this exact size screw," "I'm looking for a lightbulb that is this size, can you help me please?" And they're, like, "Yeah, come on over here."

Gross: I end up asking, like, I have like an outdoor question, and I end up asking the guy who makes the keys, and he's like, "I don't know, not my department. You got to go to the other side of the store, Sir." I was like, "Okay, fine."

Hill: Alright, let's wrap up our retail show today with Urban Outfitters. And, look, the headlines about Urban Outfitters' quarter are just awful. I mean, the profits and revenue were far worse than expected. Urban Outfitters' stock is down 7%, and that appears to be the best thing I can say about it, that it's only down 7%.

And I'm not trying to pick on Urban Outfitters, but why is this stock not down more? This seemed pretty bad.

Gross: It is pretty bad. I mean, its stock down maybe 40% on the year, so it's already gotten a big chunk taken out of it. You couldn't expect anything good to come out of this, with all the stores basically closed. Stores were closed for half of the quarter, basically. So, whether it's Free People, Urban Outfitters or Anthropologie; all just terrible, really. Comp sales overall down 28%, with overall sales down 32%.

These are preliminary results, by the way. They have some things that they're looking at. And this is, I think, one thing investors will be focusing on, they're looking at perhaps taking asset impairment charges. And so far, they've taken a provisional $14.5 million charge for, as I said, they weren't specific for some type of asset impairment. And then another $43 million reserve for inventory obsolescence. Apparel retail being a tough business, and you know, sometimes you have to be promotional or you have to write down inventory just to get rid of it. So, certainly, that's not good to see either.

Only positive, low double-digit growth in online sales. So, we can point to that. I guess, not that surprising, but this goes back to what we were saying earlier about apparel, right? Do Targets of the world take Urban's business or is there still going to be a place for, kind of, this urban chic, kind of, Free People stores?

I think in Urban Outfitters' case, the answer is, yes, because I think people really like Anthropologie, they really like the namesake Urban Outfitters. And if my family is any indication, Free People has been pretty strong as well right up until the virus hit.

So, I think they will recover, but for now it's brutal.

Hill: Yeah, one of my thoughts when I was looking at this quarter, because the last time you were on the show, one of the things we talked about was, in a time like this, how important, more than before, it is to have a strong balance sheet. And so, when I saw what was happening with the stock, and look, this is a $1.6 billion company, this is not like some of the retailers that we've been talking about over the past couple of weeks, where the market cap is down to a couple hundred million or something like that. I'm assuming there's some stability in Urban Outfitters balance sheet that some of these other retailers don't have, but it's definitely going to be a rough six to 12 months for them.

Gross: It's going to be a rough six to 12 months. I think the balance sheet is fine-ish, it could always be better, but you know, we're not talking about one of these companies that isn't in imminent trouble and really hustling to figure out what to do going into crisis mode. But as you say, they're going to have to hunker down. I mean, we are starting to reopen across the country, and that includes retail and that includes malls. We all hope that it's not too soon and that this doesn't end up reversing course, but things should start to follow-through and improve and their balance sheet should get them where they need to be.

Hill: But the other thing that's going to be interesting to see is, how do, not just Urban Outfitters but, sort of, these smaller retail outfits, particularly on the apparel retail side of things, how do they manage with the issues that we talked about with Target and Home Depot?

We don't really hear Urban Outfitters talking about, like, here's the hundreds of millions of dollars we spent on employee wages benefits and cleaning the stores. And presumably, as things start to open up, they're going to have to figure that out as well. Like, yes, as things open up, that's more of an opportunity for Urban Outfitters, but presumably, they're also going to have to spend -- you know, maybe they deal with employee benefits and wages in a different way, they're absolutely going to have to spend more money on cleaning, aren't they?

Gross: Without a doubt; they all will, and restaurants included. And that's going to take a hit at the margins, perhaps permanently or semi-permanently until vaccines are widely adopted and everyone feels a little bit more comfortable. So, maybe in a year or two, that subsides to a certain extent, but for sure, expenses are going up and margins are going down, and that will likely be reflected in the stock prices, because profits are going to take a little bit of a hit as a result.

Hill: Alright. Ron Gross, always good talking to you.

Gross: You too, Chris. Thanks!

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd, I'm Chris Hill, thanks for listening, we'll see you tomorrow.

Chris Hill has no position in any of the stocks mentioned. Ron Gross owns shares of Costco Wholesale and Target. The Motley Fool owns shares of and recommends Home Depot. The Motley Fool recommends Costco Wholesale, CVS Health, and Lowe's and recommends the following options: long January 2021 $120 calls on Home Depot and short January 2021 $210 calls on Home Depot. The Motley Fool has a disclosure policy.


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