Hardline Retail 2009 Outlook
SECTOR REVIEW
A Whole New World
“A whole new world…I've come so far, I can't go back to where I used to be, A
whole new world, That's where we'll be” --Aladdin and Jasmine, Aladdin (1992)
As Aladdin and Jasmine sing in “A Whole New World”, 2009 represents the
beginning of a whole new world for hardline retailing, one that requires investors
to rewrite the investment playbook used for this group since its beginning.
Gone are the days of constantly growing consumer spending, consistent square
footage growth, consumers living off of leverage, cheap debt, ever expanding
real estate, access to cheap imports, etc. Get used to the days of consumer deleveraging,
slower to no square footage growth, deflation, and a more cautionary
spending environment.
While that may seem bad, an environment of fewer competitive openings, higher
margin opportunities, more power over suppliers, stable pricing and high free
cash flow yields is quite appealing for the winners. However, will it be as rosy as
we hope? That depends on just how un-levered consumers wish to become and
how well the stimulus and efforts to improve credit flow work. We assume that
even if successful, we will not be returning to the old days and that is the
underlying assumption in this report.
That new world will clearly be impacted by Treasury Secretary Geithner’s
announcements this morning and much of this report is written on an
assumption that the efforts will be made to stabilize the housing and credit
markets. However, we assume that any positive impact shows up in 2010
results, not before.
So what will the new world look like and what should we own in it? The
investment question is what will margins look like on the other side of this
slowdown, meaning can we return or exceed previous highs or are we destined
for much lower margins due to slower consumer spending? We believe for the
most part not, but we do believe that margins have nice upside from these
depressed levels.
We believe the winners for 2009 will evolve from four camps: 1) those left for
dead by investors that actually survive and prosper, including Dick’s and
H.H.Gregg, 2) less macro-dependant winners that are well positioned if the
economy continues to weaken, including the DIY auto retailers and pet supply
retailer PetSmart, 3) consolidation winners, including Staples, Best Buy, and
Bed Bath & Beyond, 4) early cycle winners, including Home Depot and Lowe’s,
followed by Bed Bath & Beyond and Best Buy also in this camp.

Hardline Retail 2009 Outlook:
A Whole New World
Introduction
“A whole new world…I've come so far, I can't go back to where I used to be, A whole new
world, That's where we'll be” --Aladdin and Jasmine, Aladdin (1992)
As Aladdin and Jasmine sing in “A Whole New World”, 2009 represents the beginning of a
whole new world for hardline retailing, one that requires investors to rewrite the investment
playbook used for this group since its beginning. Gone are the days of constantly growing
consumer spending, consistent square footage growth, consumers living off of leverage,
cheap debt, ever expanding real estate, access to cheap imports, etc. Get used to the
days of consumer de-leveraging, slower to no square footage, deflation, and a more
cautionary spending environment.
While that may seem bad, an environment of fewer competitive openings, higher margin
opportunities, more power over suppliers, stable pricing and high free cash flow yields is
quite appealing for the winners and we retain our outperform for the sector. However, will it
be as rosy as we hope? That depends on just how un-levered consumers wish to become
and how well the stimulus and efforts to improve credit flow work. We assume that even if
successful, we will not be returning to the old days and that is the underlying assumption
in this report.
That new world will clearly be impacted by Treasury Secretary Geithner’s announcements
this morning and much of this report is written on an assumption that the efforts will be
made to stabilize the housing and credit markets. However, we assume that any positive
impact shows up in 2010 results, not before.
So what will the new world look like and what should we own in it? The investment
question is what will margins look like on the other side of this slowdown, meaning can we
return or exceed previous highs or are we destined for much lower margins due to slower
consumer spending? We believe for the most part not, but we do believe that margins
have nice upside from these depressed levels. We first look at the demand versus supply
equation for our retailers, with segment analysis of the same later in this report.
One of the most important questions, as the chart below highlights, is whether the US’
reliance on consumer spending changes, with that percent dropping to join other
industrialized countries? If it does, then this sector will not enjoy the recovery that to some
degree is already being priced in.