Standard Life Investments

Through the Lens

Elementary changes to retailing - Global Equities, US

  • Avoiding the risks of faulty generalisation
  • Creation of the retail ‘omnichannel’
  • Generating customer loyalty

For fans of Sherlock Holmes, it is often easy to see why inductive reasoning might be a key part of any investment process. Yet, for those more deeply schooled in logic such an approach also presents risks. In particular, evidence available from a sample might lead to false conclusions about a wider population, or so called faulty generalisation. One of the advantages of taking a research-led approach to stock selection is that each company must be assessed on its individual merits rather than some inferred generalisation.

As a bottom-up stock selector we frequently see companies that are undervalued by the market due to sector or regional biases. The retail sector is an area where industry concerns have appeared to overwhelm idiosyncratic positives at a stock level. Investors have long seen growth in e-commerce as a structural threat to traditional bricks and mortar retailers, and by now this is a consensus view. However, selected retailers quickly saw the threat, and reacted to this by adjusting their pricing and business models, in turn becoming a credible competitor to e-commerce players. This is difficult for all firms to do. To succeed in so-called ‘omnichannel’ retailing requires excellent inventory tracking systems that monitor merchandise in stock across offline stores and online distribution centres, best in class logistics facilitating delivery and handling of returns. Few companies have this.

One such retailer is Macy’s, which has invested heavily in its omnichannel retailing under the One Macy’s programme. We expect the company to start benefiting from this competitive advantage, whereas the market still regards Macy’s as a structurally challenged business. Of course, not all online retailing expertise can and should be generated in-house. Increasingly, retailers use external service providers to help combat online threats such as Amazon. One such provider is Alliance Data Systems (ADS). It operates loyalty schemes and store cards that enable even mid-size retailers to crunch customer transaction data. This enables them to deliver targeted promotions and offers normally associated with online leaders like Amazon and Google. We see ADS continuing to grow, perhaps to a greater degree than is priced in by other investors.

Again, this is all about stock selection. Some retailers are facing up to the challenge posed by online retailers, transforming their business models and adapting to the new environment. Others still rely on the old ways of doing business. These latter firms are likely to see market share slip in comparison to online leaders and more nimble competitors.