Basic Overview of the Consumer Sector
Mod Note: Each day we'll be posting the top WSO forum posts of 2014. This one was originally posted on 12/7/14 and ranks #32 for the year by total silver banana count. You can see all our top ranked content here.
We have done these in the past, if you're looking for a different sector we have already covered the following:
- Financial Institutions Group
- Technology Media and Telecom
Let get started.
1. Apparel Companies (ANF, GPS, GES, URBN)
For this sector we'll talk broadly. The metrics are easy to understand for most people and it should make for a quick read.
Same Store Sales/Comparable Store Sales: For apparel companies (and a plethora of other consumer companies as you'll see) you'll be tracking monthly sales metrics by store across all geographies. This data is available on a monthly basis. **Note same store sales figures are on a monthly basis so if you work in consumer IBD get ready for those early morning releases
Sales Floor Performance Metrics: This is another easy one to understand, you're looking for outperformance relative to peers on the following metrics: Sales per square foot, average sale/customer, costs/sq foot. The metrics are exactly as they sound, you're looking for sales and cost efficiency on a per store basis and by geography as well. The most common of the three mentioned above is of course Sales/Sq foot. Finally, if you want to get into the nitty gritty of each product line you can ask specific stock to sales ratios of key product launches at the company (stock to sales simply being how many items of the new product were sold are in stock and were sold over the last quarter/month/year)
Online Metrics: This is even easier to understand! Any website (including a retail online store) is simply looking to monetize its online customer base by tracking the following: Average sale per customer, conversion rates – number of page views to sell product X or number of products sold after clicking on XYZ advertisement and of course the mix of items being sold split by gender/age range and product line.
Production Efficiency: Assuming the company you're looking at does the manufacturing of all the items (shirts/sweaters/shoes etc.) you can get into more detail by tracking manufacturing efficiency. If you order say 10,000 pairs of shoes and you have to create 11,000 of them your efficiency is 91% (this 9% adjustment reflects manufacturing errors/quality control issues).
Geographic Roll Outs: For larger companies, particularly international expansion, we want to track store growth rates, margin profile by geo and open to close ratios (number of stores opened in geo X versus number that were forced to close). Without digging too much into the details here, many consumer companies use debt to continue rolling out new stores in a particular geo. Easiest way to think about the process is as follows: Open store 1 with debt, wait for cash flow to turn positive, use remaining cash flow to fund opening of store 2… repeat process assuming stores turn cash flow positive within a reasonable time frame. Some stores will not hit the metrics, shut them down, go back to square one and roll out in a new geo or the same geo but different location.
Valuation: From a valuation range perspective you're looking at roughly 5-15x EV/EBITDA, 10-30x P/E and PEG's of 0.9-1.9 or so.
Summary: This is a great space to understand since it is older and easy to pick up if you're younger. In short the ideal apparel company is outperforming on all of the key retail metrics mentioned above and doesn't have any competitive issues (example NIKE recently competing aggressively with Lululemon Athletica). The ideal company would look something like this: 1) High sales growth relative to comps, 2) revenue/sq foot increasing, 3) OPEX/Sq foot decreasing, 4) Average sales per customer increasing, 5) manufacturing efficiency improving towards 100% (will never reach 100% of course), 6) online metrics improving purchase/pageviews and conversion rate on advertising.
2. Grocery Stores (KR, WFM, SWY)
Whole Foods Market Example:
Everyone reading this is likely familiar with Whole Foods, the Organic health focused supermarket. While a few items such as positioning within the supermarket chains (focusing primarily on organics, higher-end and health conscious shoppers) are a bit different, the metrics to track can be used broadly as well.
WFM Metrics to Know: Roughly speaking: $14B in sales, 35% gross margins, 9% EBITDA margins, 400 stores, 15M square feet, square footage growth of high singles to 10%, comparable stores growth mid singles (better than more mature at low singles)
Same Store Sales: Again! Same metric will be tracked and is a staple metric across consumer as we mentioned. You want to see improving sales/sq foot growth and decreasing OPEX per sq foot in an ideal environment.
Employment Tracker: This is an important metric to track and is arguably more important for higher end grocers as consumers will purchase less if unemployed. Generally speaking when there are job losses (08 recession) then grocery sales decline materially as well. This is a bit more specific to a company such as whole foods as lower end cheaper goods would not be hit as hard during a recession (pasta/grains/bread as a simple example of a food that would be hit less in a recession).
Revenue Mix: All revenue is not created equal and you can see the expansion of four different streams within a grocery store. Bakery, branded, Hot/prepared food, and regular produce. Generally speaking we would want to see all of these lines growing, however an emphasis will be placed on branded items (think of grocery specific brand of produce, you see this at most major grocery chains) as they would command higher margins. Simplistically, if you own the entire process/chain you can usually generate higher margins over the long-term. Finally, prepared foods generally command higher margins as well (so focus in on prepared and branded/private label!)
Branding and Positioning: Most younger readers will skip this piece since it is unrelated to financials but it is hands down the most important part of evaluating the future. The ability to charge a premium price and command higher margins will be tied to the business perception of Whole Foods. You want to track (surveys can be a good measure) how the brand's perception is holding up. If people begin to believe the products sold at whole foods are no longer healthy or no longer "high end" the business model can suffer tremendously. Sales decline, pricing comes under pressure as people are unwilling to pay a premium causing margin pressure as well.
Valuation: From a valuation range grocery stores are about 1 turn higher on a EV/EBITDA basis versus apparels and a few turns higher on P/E metrics as well. You're looking at roughly 7-16x EV/EBITDA, 15-30x P/E and PEG's of 1.5-3.5.
Summary: A lot of the metrics are similar, however for grocers you can zero in on some other key metrics. We chose Whole Foods in particular as it is a bit more interesting due to the growth of "specialty" grocery stores versus simple blanket super markets. Looking for 1) same store sales growth as always 2) Branding/positioning to protect margins, 3) ideally expansion of branded product sales, 4) opex reductions per square foot and 5) private label/prepared food growth.
3. Automotive Parts (AAP, AZO, KMX)
Advance Auto Parts Example:
For those that are unfamiliar AAP is a ~$10B company and operates at ~10-11% EBIT margins. Given the mature nature of the business investors focus in on Stores Comps (exactly as it sounds comparable growth for sales at their set of stores) and operating margins.
To make this sector a bit more interesting AAP recently acquired a large aftermarket parts provider (General Parts International, $2.9B in revenue and $173M in EBIT). Given the size of the acquisition (taking AAP from a $6.5B company to a ~$10B Company) allows investors and analysts to take sides on the name determining if the acquisition will be a net positive or net negative.
Cost Consolidation: While the Company outlines a $160M cost cutting program in order to estimate if this is viable you're going to pour though locations and sales numbers to find if the transaction would be Accretive or not. In simple terms, if there is an AAP facility sitting next to a General Parts facility, if one can be shut down but sales are retained the leverage from the model improves. (Note: AAP pre acquisition was a 4000 store group primarily on the east coast and GPI has a broader reach Canada + entire USA but with 1,250 stores)
Commercial and Retail Customers: Second in this analysis after running simple consolidation numbers on each geography is to split the customers by corporate and retail clients to determine how many will leave post consolidation. Simplistically, if you assume the material sales reps and executives remain onboard, you would have a lower attrition on the commercial side given the change is simply a swapping of logos. From a retail standpoint, it could cause issues as stores may suffer from over crowding or lower price competition – decreasing sales. (Note: AAP pre acquisition was roughly 40% commercial, 60% retail and GPI was 90% commercial and 10% retail)
Distribution Centers: This is similar to store overlap. If distribution centers can be consolidated cost savings can be seen over the NTM period as well. (Note: AAP had 12 distribution centers while GPUI had 38 at the time of the transaction)
Headcount: As many of you already know, head count reductions will of course occur. Overlapping jobs are eliminated and those that are high value are offered stock/competitive sales compensation to stay onboard. (Note: AAP had 54K employees pre acquisition and GPI had 17K)
Valuation: From a valuation perspective multiples are in the following ranges 8-13x EV/EBITDA, 13-30x P/E and PEG's of 0.6-1.6.
Summary: More likely than not, this space is rather boring to most of you given that 1) the industry is mature, 2) the metrics are easy to understand 10% margins with 12% as a goal and 3) Simple single digit y/y growth… It is still a solid place to start if you want to look through basic financial statements.
We recommend flipping through the slide deck of the acquisition, linked here: http://phx.corporate-ir.net/phoenix.zhtml?c=130560&p=irol-presentations (October 16, 2013)
4. Quick Service or "Fast Food" (MCD, BKW, PZZA, CMG)
Mc Donalds Example:
Sticking with examples, it is best to start with the quickest metric for fast food chains (Same Store Sales growth or SSS for short – it is back again!). Generally you're looking at ~2% same store sales growth on a global basis, ideally MCD grows at ~4-5% and you obtain ~6-12% EPS growth off of operational improvements and capital allocation (share repurchases).
While ROIC is also a valuable metric in the space (and for Mc Donalds), to simplify the view we'll focus on revenue and EPS drivers.
Inflation: With larger consumer companies inflation can be a tailwind or a headwind as people decide to purchase food at home or away. In short if the cost of food at home is increasing more than the food away from home, this would be a tailwind. If they are in-line would be neutral and if decreasing would be a headwind. Tracking inflation in this manner helps an investor paint a picture of where dollars spent are going and where price inflation is likely to occur.
Store Unit Growth: Assuming inflation assumptions are in check we can move down from the macro a bit and begin tracking total store unit growth. Of course the stores need to be profitable and we're looking for y/y growth in total units that is *higher* than its peers. In a positive situation, you're looking for unit growth to increase low mid single digits (call it 3-5%) and see these units turn into revenue growth meaning long-term growth of up to 5% (a solid number for a major corporation such as MCD). **Note this also explains the valuation/multiple discrepancy between a MCD (lower growth) and a CMG (high growth).
Geographic Growth: For major companies, not start up or growth quick service firms, you're going to splice revenue growth into geographies as well to determine if market share is being gained or lost and if each geo is increasing the operating margin line. This means splitting our same store sales numbers (SSS) by geography as well.
Food vs Beverage: After building a good high level view, you can then splice the market into food and beverage by looking at market share (on-premise and off-premise eating) and beverage sales (Coffee, hot/cold, smoothies). Generally the margins on drinks are higher relative to food so it may be a good idea to start in this segment to determine the underlying beverage growth and competitive landscape (Starbucks, Potbelly, BK etc.). Specifically, you would ideally map out the revenue by beverage (Mc Café as an example) but this will be difficult for MCD and more useful when looking at smaller consumer fast food companies.
Company vs. Franchise: Next, instead of splitting by beverage and food you will split the company based on franchise and restaurant income. For Mc Donalds you're looking at a ~$20B Company sales line and a ~$10B franchise line. Franchised income will command higher margins as they are calculated by taking revenue minus rent and depreciation. Net net, you're looking at~30% on the operating margin line for the firm.
Valuation: From a valuation perspective multiples for quick service companies are in the following range: 9-18x EV/EBITDA, 13-33x P/E and PEG's of 1.1-2.6.
Summary: Even with larger firms such as McDonalds there are a lot of moving pieces as you have different margin profiles and growth trajectories depending on the type of quick service Company you are working with. Just remember the main differentiators: 1) Same Store Sales Growth, 2) Growth by franchise/Company, 3) Margins and growth by beverage/food and 4) Geographic expansion.
5. Consumer Staples (KO, PEP, XLP)
No we are not going to use the classic Warren Buffet investment in Coca-Cola example which you can read in 20 different variations with a google search. Instead this is the last sector we'll cover as a lot of the items are redundant as you've seen from above. The main idea for the consumer staple space is the metrics become much more macro focused and in the case of Coca-Cola… Geographically macro specific as well.
Coke is a $50B top-line company (low single digit revenue growth) with mid twenties EBIT margins and EPS growth in the mid to high single digits.
Profit Growth: As you can imagine the revenue story is less compelling. Coca-cola is a massive consumer staples company and the law of large numbers weighs on the top-line growth rate… For those that are interested in the sheer numbers, Coca-cola sells ~28-30 billion unit cases in a single year.
The positive side? Profit growth can be quite compelling. Assuming volume continues to improve (concentrate sales and unit/case sales) leverage can be seen from the operating model assuming solid execution. Simplistically, continue to see stable to slightly improving volume growth/revenue stabilization and cost efficiencies in theory should drive mid single digit y/y EBIT growth.
The Weather: This is a serious metric to track for major companies such as Coca-cola. Inches of precipitation can cause material headwinds for the company as precipitation leads to lower consumer sales in general. If you don't believe this, look up the weather issues in February of 2014 and you can find many companies citing this as a headwind. It matters.
While it is difficult to predict global weather trends in the future, it is important to track the metrics across geographies so y/y growth rates can be appropriately adjusted. Using the February 2014 example, y/y growth rates should be materially better in Q1 of Calendar 2015 as the y/y comparisons will be easier to beat.
Competitive Dynamics: Everyone on here knows Coke's main competitor. Pepsi. Tracking their advertising spend is a material driver to Coca-cola. When you speak to the general public Coke is generally a better heralded "brand name", however aggressive marketing tactics from its closest direct peer can negatively impact earnings.
For those interested in the market share for carbonated drinks it is roughly as follows: Coca-cola at 40%, Pepsi at 30%, Dr. Pepper at 20%, remaining at 10% (primarily private label). On the Juice side of the market: Pepsi at 20%, Coke at 10%, Ocean Spray at 8%, Kraft at 8%, Campbell at 8%, Dr. Pepper at 7%, remaining is other.
International Branding, Taxes and GDP: Going to attempt to lump all of this into a single paragraph as well. You will want to track GDP growth by country (in Coca-cola's case the primary regions are USA ~40%, Japan ~10%, Mexico & Brazil at 6% each and China at 6%). After tracking revenue growth by region we then move on to analyzing operational issues (taxes and government regulation). You would analyze the performance here by tracking EBIT margins by Geo and keeping up to date with changing government laws (for example some unhealthy items are beginning to see increased taxation).
Valuation: From a valuation perspective multiples are in the following ranges ~14-22x P/E , EBITDA of ~11-16x and in this case the DCF valuation metric is much more meaningful (you could safely assume a low single digit terminal growth rate linked to revenue and a discount rate in the high singles).
Summary: As we stated above, the large staple players become macro centric names given sheer size. However, it is interesting to watch if you want a broad understanding of macro: 1) geo political issues, 2) high level competitive dynamics and 3) government intervention.
That about does it. Similar to previous overviews feel free to add points in the comments or ask any questions you may have. There is no way to hit on every sector (example splitting into tobacco, poultry, specialty hardlines/softlines, high growth premium brands, big lots vs. general super markets, discount and drugs etc.).
With that said the below top 10 bullets will work if you want to know the basics of the space and didn't want to read the above:
1) Same Store sales (monthly) – track the growth of each store by geo
2) Sales / square foot – see if the company is doing a good job of optimizing its foot print
3) OPEX / square foot – see if the firm is doing a good job curbing costs
4) Competitive landscape – track exactly where in the consumer sector they are branding, who they compete with and advertising dollars do matter
5) Inflation and CPI numbers
6) Growth by segment: can be as simple as beverage vs. food and online versus retail. Track growth and margins by segment
7) Franchise vs. Company growth
8) Weather can drive consumer spending
9) Cash flow is imperative as we mentioned many consumer companies use debt and roll out to cash flow positive and open new stores with subsequent cash flow. Hence emphasis on EBITDA in the valuation sections
10) Valuation use P/Es, EBITDA and PEG (generally). If smaller use sales metrics. If a large consumer staple company (XLP) then a DCF can certainly work.