Company Notes Digest 3.10.17

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Each week we read dozens of transcripts from earnings calls and presentations as part of our investment process. Below is a weekly post which contains some of the most important quotes about the economy and industry trends from those transcripts. Click here to receive these posts weekly via email.

Arguably the biggest story of this quarter has come late in the earnings season. Retailers are truly coming to terms with the massive challenges that the industry is facing. This isn’t a new realization. CEOs have known this is coming for more than a decade, and they have spent at least the last five years heavily investing in “omni-channel.” But this is the first quarter where CEOs are recognizing that they’re losing the war. Amazon is taking a larger and larger bite of retail sales every quarter, and because retailers have high fixed cost bases, every lost sale becomes more and more painful. This means that the process is likely to accelerate from here.

CEOs have to be optimistic for their shareholders, which is why investors have to train themselves to read between the lines. All of these CEOs are talking about seizing the moment and investing in new platforms. But the vast majority of these companies are trying to take hills that have already been lost (more than a decade ago).

For most of these companies, investing now is just throwing good money after bad, which is the antithesis of being a steward of capital. However, most of these CEOs are staring their career’s mortality in the face, and when that happens its easier to go down with the ship than tell everybody to get into life boats.

There are some management teams who will tell you the truth and those are the ones to listen to. The only way to have a positive outcome is to see the playing field clearly and operate without bias. Adversity is what separates great management teams from weak ones.  Invest in great management teams.

The Macro Outlook:

Retailers can’t hide from their problems

“Our industry is the midst of a seismic shift, and, of course, you read the headlines. In fact, many of you write the reports, we’re operating in an incredibly challenging environment. All across the retail industry, many of our competitors are aggressively rationalizing their assets. They are closing stores, exiting markets. They’re cutting costs just to keep their heads above water. We’ve not seen this number of distressed retailers since 2009 in the Great Recession.” —Target CEO Brian Cornell (Retail)

There’s too much retail space in the US, especially in a digital world

“Retail square feet per capita in the United States is more than six times that of Europe or Japan. And this doesn’t count digital commerce. Our industry, not unlike the housing industry, saw too much square footage capacity added in the 90’s and early 2000’s. Thousands of new doors opened and rents soared; this created a bubble, and like housing, that bubble has now burst. We are seeing the results; doors shuttering and rents retreating. This trend will continue for the foreseeable future and may even accelerate.” —Urban Outfitters CEO Richard Hayne (Retail)

Old empires are shrinking

“we made great progress narrowing our geographic focus to North America. While we have successfully provided tremendous value to business customers across Europe over the years, we have not been as successful creating shareholder value in Europe. We believe it’s in the best interest of our shareholders to narrow our focus to North America” —Staples CEO Shira Goodman (Retail)

Management teams are scrambling to build new platforms

“We certainly view 2017 as a year of investment. In 2018, we’ll continue to transition as these different initiatives begin to mature. As we get into 2019 and beyond, we certainly expect stability and a return to growth…We’ve got to invest to grow. We’ve got to reimagine our stores. ” —Target CEO Brian Cornell (Retail)

“we plan to do what any good portfolio manager would. Invest resources in the most promising opportunities, diversify to lower risk, and increase liquidity…Our highest priority is where we’ve had the most recent success, digital” —Urban Outfitters CEO Richard Hayne (Retail)

But they are still holding on to their old ones

“First, let’s talk stores, our key competitive advantage. They are at the center of everything we do for our guests regardless of how we deliver. The 40% digital growth we saw in December, they enabled it.” —Target COO John Mulligan (Retail)

And although the economics of e-commerce are good

“to kind of call out the profitability of e-commerce versus the profitability of the store, we’re not ready to do that. But I will tell you that the e-commerce business is probably more profitable than you think.” —Dicks Sporting Goods CEO Ed Stack (Retail)

This is worse than a zero sum game

“This would be fine if the increase in DTC sales were wholly additive, but they’re not. Digital shopping is partially replacing store shopping and thus is negatively impacting store traffic and store generated sales. Flat to negative store ‘comps’ are causing occupancy deleverage and eroding four-wall margins.” —Urban Outfitters CEO Richard Hayne (Retail)

The positive is that this isn’t the first paradigm shift for retailers

“these inflection points come around every generation or so. And strong retailers endure, while others, well, they don’t. Pick your era defining change throughout history from downtown department stores to suburban malls, catalogs, e-commerce.” —Target CEO Brian Cornell (Retail)

And it’s a good time to pick up real estate if you can use it

“We look at this going forward that now is absolutely the right time to be patient from a real estate standpoint, with all the real estate that’s going to come up on the market. Penney’s announcing stores that they’re closing, Macy’s announcing stores. Some other people that are rumored to be closing stores or — consolidation in this industry is not over. And this is a time that we’re going to be very patient going forward.” —Dicks Sporting Goods CEO Ed Stack (Retail)

Meanwhile, in other macro news…

Demand still hasn’t caught up with sentiment

“I’m optimistic about some of the changes that we see more broadly in the environment but at this point in time there’s nothing really that’s quite happened yet. Tax reform is still a discussion, it hasn’t occurred” —Verizon EVP John Stratton (Telecom)

Inflation may not be as strong as advertised

“Regarding deflation, overall, primarily in the US, we have seen deflation in the 1%, 1.5% range in February. Departments such as foods, sundries, frozen foods, liquor meat, dairy showed the most deflation on the foods and sundries side. On the non-food side consumer electronics continue to be deflationary, primarily in the TV category…The collective view is inflationary, or less deflationary, for the next few months and maybe a little inflationary, but it’s a crap shoot.” —Costco CFO Richard Galanti (Retail)

“we also have to acknowledge the ongoing challenges facing our industry. Our customers are facing a difficult retail environment due to deflation and increased competition. We view deflation as cyclical, inflation will come back at some point but while it’s here, it’s leading to some very real challenges for us and our retail customers.” —UNFI CEO Steven Spinner (Food Distributor)

A border adjusted tax would probably change that quickly

“We don’t believe it’s good for consumers – it’s going to raise prices…we personally don’t buy into the fact that it will be offset by a big rising dollar. We don’t know what’s going to happen with the retaliation out there by other countries, and we’ll see. But as a retailer, we definitely think that it’s bad, and we’re against it.” —Costco CFO Richard Galanti (Retail)


Housing markets are strengthening

“we definitely are feeling a little strengthening in the marketplace and I think our sales per community, our contracts per community are certainly an indication of that. If I look around the country, I’d say we’re feeling some strengthening, certainly in Northern California in the Sacramento area that has been strong. We’re continuing to see a strong Texas market, the Arizona market in Bromley in Phoenix that has been strengthening as well.” —Hovnanian CEO Ara Hovnanian (Homebuilder)

Asia leads the US in digital banking

“I would say that we’re most advanced in digital right now in Asia as you might suspect. And Asia kind of leads the U.S. and the U.S. certainly leads Mexico…In Asia, if you didn’t have a great digital offering you would be dead. And clearly, the way the U.S. is going that’s the same way it is.” —Citigroup CFO John Gerspach (Bank)


Digital spend is now 55% of Home Depot’s marketing budget

“You might be surprised to know that a better part of 55% to 60% of all of the marketing that we deployed now is in the new media or digital world…very active with Google search terms…very active social media practice. We do a lot of retargeting for customers and are constantly looking at ways to make our marketing and advertising more personal…and also more location aware. So, talking to you based off the weather patterns that you’re experiencing in your local neighborhood, those are all things that we have and we’ve deployed in our marketing spend.” —Home Depot CMO Kevin Hofmann (Retail)

“Celebrity” is a commodity with rising value

“In January to broaden Revlon’s social reach and digital relevance we announced the signing of Gwen Stefani as our new global brand ambassador and four new digital influencers” —Revlon CEO Fabian Garcia


5G will change the architecture of the telecom network

“the reinvention that’s required has surprised us…RF design is a really critical point. We’ve run and managed and design these networks a certain way for 20 years and the 5G paradigm is completely different. I think that’s going to surprise some people.” —Verizon EVP John Stratton (Telecom)

5G requires more small cells

“it’s going to require a lot of small cells, lot of space, lot of power, a lot of backhaul…it doesn’t propagate walls very well, or trees or other obstacles and so we think there is going to be – in order to get it effectively into the home and an antenna is required to be mounted on the house to get the propagation through the house that’s required.” —Comcast Cable CEO Neil Smit (Media)

It probably wont be deployed on mobile until 2020

“maybe the end 2019 into 2020 where you might see the first sort of delivery of mobile based 5G. And remember also to scale you have to seed the base of handsets and so you’ll have that curve. There’s a cost curve, there’s an initial integration that needs to happen.” —Verizon EVP John Stratton (Telecom)


Connected cars generate a lot of data, but who owns the data?

“there is an awful lot of engineering resources going in where the OEMs realize the vast amount of data that they could provide, how do they want to collect it and how do they want to retain it and how they want to process it…One of the things we have to remember is that the customer owns the car. And so the data coming off the car belongs — I think most people feel belongs to the customer.” —Sirius XM CFO David Frear (Telecom)

Miscellaneous Nuggets of Wisdom:

If you optimize your business for any single metric it should be Net Promoter Score

“we put in one measurement system, Net Promoter System and everyone is measured on that and paid on that including Brian and myself. It focuses on what the customers want and need, and whether they would promote your service to a friend or family, and we also have an employee NPS score, which gets the feedback of the employees who are fundamentally trying to service the customer. So it’s been a real morale lift for the employees.” —Comcast Cable CEO Neil Smit (Media)

You’re better off paying a fair price for a healthy company than a low price for a dysfunctional one

“we typically don’t like to acquire turnarounds or companies that are financially troubled. We’d rather pay a fair price for a company that’s doing well than a very inexpensive price for a company that’s not doing well.” —UNFI CEO Steven Spinner (Food Distributor)

Full transcripts can be found at