Retail

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Analyst Viewpoints Series l January 2013

Retail New Shopping Habits

SUMMARY At Janus, we strive to deliver better client outcomes through the disciplined pursuit of independent ideas. We extend this commitment to our clients and partners by providing access to the insights and opinions of Janus’ seven global sector research teams via monthly analyst interviews. In this edition of Analyst Viewpoints, Janus’ Eileen Hoffmann discusses her views on the retail industry with Director of Global Equity Strategies Adam Schor, including the recent holiday shopping season and what the trend toward more online sales means for the industry. Eileen Hoffmann Equity Research Analyst, Consumer

Q: HOW HAVE RETAIL SALES GONE SO FAR THIS YEAR AS WE APPROACH THE END OF THE HOLIDAY SEASON? Eileen Hoffmann: For the calendar year, retail sales growth actually has been pretty strong, up nearly 5% year to date through November. Most of that strength came in the first and third quarters of this year. November was a little bit softer due to the effects of Hurricane Sandy and the elections. Holiday sales got off to a very strong start over the Thanksgiving/Black Friday weekend, and actually were above forecasts at a 4% year over year increase versus expectations for a 3% gain, but December sales have been a little bit soft so far. December’s softness thus far we think is due in part to consumers being concerned about the pending fiscal cliff and their tax burden potentially increasing next year. That said, we also believe that mobile and tablet sales are very strong this holiday season, which are not captured in the weekly retail sales data that we analyze, so this trend will likely positively influence the actual holiday sales results. Historical sales patterns for the holiday season show a lull in the first two weeks of the month followed by an acceleration during the 10 days before Christmas, which are often as strong as the Black Friday weekend. While we haven’t yet seen how those final 10 days will play out, we do think that holiday sales will be a little softer than originally forecasted yet still up a healthy 2.5%. Q: WHAT ARE THE MOST IMPORTANT NEW TRENDS EMERGING IN RETAIL SALES THIS YEAR? Eileen Hoffmann: E-commerce sales have been trending well above retail sales growth. So far this year, online sales are up 15%.That’s a big jump in a single year. The boost in online sales is an incredibly positive trend for the entire retail sector because those online sales add to the company’s total sales growth. Some might think there has simply

KEY POINTS •

Online sales are not just replacing in-store sales: they are helping companies incrementally grow revenue.

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An online presence enables companies to more successfully identify new countries where they can expand their retail footprint.

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The companies gaining market share are those creating a seamless shopping experience between the physical store, web site, mobile devices, tablets and social media.

been a shift from in-store sales to online, but for most companies, sales online are incremental to total revenues for a retailer. Having a social media and online presence has given companies a greater number of touch points with their target customer. Those touch points create greater customer loyalty, which has proven to translate into more frequent and larger purchases. Beyond an incremental positive to total sales growth, an online presence also is allowing companies to make more strategic investments with regard to building out their retail store base and also in terms of marketing and advertising expenditures. Thus, the capital being deployed in the retail industry is much more targeted and effective than it has been historically, which should over time lead to incrementally higher returns on invested capital in our view.

companies have not yet implemented seamless inventory management systems, but they will need to achieve this level of operational functionality to stay relevant and compete long term. Q: CAN YOU WALK US THROUGH AN EXAMPLE OF A COMPANY THAT HAS DONE A GOOD JOB OF LINING UP THE SHOPPING EXPERIENCE ACROSS DIFFERENT CHANNELS?

Eileen Hoffmann: The best examples in my view are Nordstrom and Coach. Nordstrom has led the industry in creating a total seamless shopping experience. Nordstrom operates what I call virtual inventory management meaning that all channels of distribution operate from one unified inventory platform. Nordstrom also was the first traditional retailer to implement fully functional handheld Apple point-ofAnother reason an active online and social media presence is sale devices in their stores, making the entire check-out and critical in today’s retail landscape is that both help clear out customer service process faster and easier for consumers. inventory at a faster rate, and even at a better price They were also the first retailer to offer free shipping and compared to having inventory sit on a stores sales rack returns and are testing same-day shipping in some markets. marked down by 40%, for example. Today retailers are None of these customer interfacing initiatives can be utilizing the web and email lists to have what are called a accomplished without a virtual inventory system. “flash sale,” in which they send an email to their top customer base offering a one-day-only 20% discount on items, for While this may not seem like high technology, creating instance, and the conversion rate of customers buying that seamless inventory is a long and costly process for retailers, inventory from the flash sale is a lot higher than buying it from most of whom have to integrate new technology platforms the store’s sales rack, thus driving incremental profitability into legacy back-office and point-of-sale systems. Nordstrom from markdown inventory. has, we believe, a five-year first mover advantage compared to many other department stores and retailers, and we’ve The quicker inventory turnover ratios and more efficient seen Nordstrom’s investments in technology pay off with capital expenditures are helping retailers generate greater same-store sales growing at a faster rate than its free cash flow. We’re seeing that extra cash flow go back to competitors. shareholders through increased dividends and share buybacks. It’s been a very positive development for the We’ve also been impressed with Coach’s transformation to a industry. multi-channel model. The company has always had strength in managing inventories with state-of-the-art back office Q: HOW HAVE COMPANIES BALANCED THE NEED FOR systems. Because of this strength, Coach was able to ramp AN IN-STORE SALES STRATEGY AND AN ONLINE up its web presence and tap into social media faster than SALES STRATEGY? most other retailers and was an early adopter of Facebook, with nearly 4 million fans today. As an example of this early Eileen Hoffmann: To be successful, a company has to blend adopter benefit, Coach offers targeted promotions to their online and in-store strategies together. Consumers Facebook followers and that drives instantaneous traffic to its today view a retailer as a brand. They want to shop for a stores and website. Coach also utilizes very strategic selling particular brand 24 hours a day, seven days a week, and techniques with popular “flash sale” websites such as Gilt have the exact same experience with the brand no matter Groupe that clears inventory very effectively and does not what channel they are shopping. A consumer wants to know damage the integrity of the brand at all in our view. What’s that for a particular brand, whatever he or she is seeing in more impressive is that the company has been able to carry terms of merchandise or price on their tablet is the same out innovative, multi-channel promotional and advertising thing being offered on their mobile device as well as on the strategies in both its retail and factory stores. company’s web site and in the actual stores. Some

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Q: HOW HAVE TRENDS TOWARD SHOPPING ONLINE AND THROUGH SOCIAL MEDIA CHANGED HOW YOU RESEARCH THESE COMPANIES?

Q: IS THE GREATER ONLINE PRESENCE CREATING MORE BRAND AWARENESS GLOBALLY?

Eileen Hoffmann: Yes. The basic benefit of the internet is that trends are now the same all over the world. What is popular and “hip” in the U.S. can be the same as what is popular in Asia or Europe. Interestingly, the emergence of online has also helped companies more effectively target new store openings globally. It used to be somewhat of a needle in a haystack process but with actual geographic sales information on a global basis, retailers now know where their customer base lives. With that information they can make more informed decisions on capital deployment in terms of We also get valuable insights from our analysts that follow e- opening a new physical store or launching a local ecommerce commerce companies such as eBay and Amazon. This helps site for a country. us better understand how the technology investments retailers are making compare to pure online retailers and Q: SINCE HOLIDAY SALES ARE SO IMPORTANT TO A what kind of returns on investment are realistic to expect. RETAILER, CAN YOU TELL US THE TYPE OF RESEARCH YOU DO DURING THE HOLIDAY SEASON? Our survey associates are also doing creative new work. We’ve always done traditional mall-based surveys. Now our Eileen Hoffmann: The holidays are the Olympics for the survey associates are tracking a network of active bloggers retail industry. Companies within the retail industry spend all on brands and establishing a network of Facebook followers year getting ready for how they will perform from who are fanatics of different brands to integrate what those Thanksgiving through the end of the year. My job as an bloggers and fans are saying into our own research. analyst is to understand how every single dollar of investment made by a retailer, whether it is operating expenses or capital Following what these brand fanatics think of a company is expenditures, are in turn positively affecting a brand, shaping important because it gives us insights into potential new a retailer’s business model and expanding consumer loyalty. product development, areas of focus and opportunity for a Being in the stores frequently over the holidays provides a lot company and essentially what consumers want and expect of clarity on how a company has allocated its capital and from a brand. whether those investments are turning into market share Q: DOES THAT MEAN THE COMPANIES ARE LISTENING gains, as measured by both sales growth and profitability TO THE BLOGGERS AND FACEBOOK FANS AS WELL? above industry peers. Eileen Hoffmann: The way we look at companies today is a lot different than it was even three years ago because a retailer’s online strategy is so important. One thing we started doing a few years back was bringing our technology team along for the company site visits we conduct. Now it is important to meet with the company’s chief technology officer, the head of online and e-commerce and the people in charge of the mobile platform.

Eileen Hoffmann: Social media is definitely integrating the consumer directly into the design process, which is exciting. Designers and merchants are having real-time discussions and getting real time feedback from their consumers. What a credible blogger might say about a current product line can actually influence what a designer chooses to make for the next season. If a company isn’t interacting with the consumer actively through these social mediums it informs us that they may be a market share loser over time, because that particular retailer might not be as current or as in touch with its customer as its competitors might be.

I typically spend a couple of days before Thanksgiving strategizing the order in which I’ll start visiting stores, dependent on door-buster promotions and store opening schedules. I begin from the time the first store opens, which this year was on Thanksgiving Day, and then I stay at it the entire weekend, including all night. This year was interesting because we expected online sales would be more important, so I split time between being in stores and shopping online. It was insightful to compare in real time the inventory and promotional offerings in stores versus online and on mobile devices, and the results varied dramatically from retailer to retailer. It has made for a very dynamic holiday season.

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ABOUT THE FEATURED ANALYST Eileen Hoffmann Eileen Hoffmann is Portfolio Manager of sub-advised portfolios related to the U.S. retail industry and is also an equity research analyst, primarily focusing on small- and mid-cap retail stocks. Ms. Hoffmann also serves as a co-team leader of the consumer sector research team. Prior to joining Janus as a senior research analyst in October 2004, she was vice president and co-portfolio manager of an all-cap consumer sector fund at Cordillera Asset Management and previously worked as a consumer sector analyst for Berger Funds in Denver. Ms. Hoffmann began her career as a sell-side analyst following the retail sector with Robertson Stephens. She also worked for Pacific Growth Equities and Equitable Securities. Ms. Hoffmann received her bachelor of business administration degree in economics from the University of San Diego, where she graduated cum laude. Ms. Hoffmann has 19 years of financial industry experience.

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