Retailers Rally While Tech Sags (Because Of The Tax Plan)
Retailers Helped By Tax Bill
The stock market indexes reflect the tax bill’s impact on earnings as the Dow rallied, while Nasdaq fell. The Dow was up 0.24%, the S&P 500 was down 0.12%, and the Nasdaq was down 1.05%. Many of the retail names did well because they have high tax rates. Gap stock was up 6.6%, Macy’s was up 6.7%, and O’Reilly Automotive was up 6.8%. The table below reviews some of the names which will be getting a big tax break next year after the bill is passed. As you can see, O’Reilly Automotive will see its tax rate go from 34.7% to 23.0% assuming the corporate tax rate is cut to 20%. When looking at these names, it’s important to find the ones with staying power. Lower tax rates don’t matter if the company can’t make a profit. The companies on this list which probably won’t be bothered by Amazon are AutoZone, O’Reilly Automotive, and Home Depot. The companies which will be bothered by Amazon are Bed Bath & Beyond, Target, and Wal-Mart. At least Wal-Mart has Jet.com to help it compete online.
Yield Curve Signals Investors Should Be Careful Buying Retail
One aspect to keep in mind is that consumer discretionary stocks do badly at this point in the yield curve. That’s because when the yield curve is as flat as it is right now (57 basis points), there is usually inflation. Inflation increases the cost of goods sold for retailers and hurts the spending power of the consumer. In the past two cycles, gas prices went up at the end of the cycle which hurt retailers. High gas prices accelerate the market share loss of physical stores to online stores as online stores don’t require people to drive to buy items; shipping is usually free when customers buy online, especially for Amazon Prime members.
Low Oil Prices Have Helped Retail & High Tax Rates Have Hurt It
Let’s look at the competitive advantage between online and physical retailers when it comes to these recent trends. There’s no question the technology improvements from online stores means they will gain share over time. However, these two factors which are oil prices and tax rates effect the speed of the shift. When consumers see the price of gas, they are psychologically impacted more than they should be when you consider the share of their spending gas represents. When they see $4 gas, they get shell shocked and drive less. That means even though Amazon might need to swallow higher shipping costs, it still comes out ahead. Of course, retailers also need to ship the goods to the stores, so higher diesel prices hurt their margins. Therefore, retailers have been helped by low oil prices in the past two years; they must be worried by the recent rally in oil.
Secondly, the high effective tax rates of retailers which mostly have their business centered in America has hurt them. Amazon has had many years without a profit as investors have supported its growth. This is while, retailers are getting penalized for being static and hurt by the tax code. Surely, that has helped online retail take market share from physical stores. Recently, Amazon has been able to reach profitability with the help of the cloud business. As we’ll get to later, Amazon is one of the few tech companies substantially helped by the tax cut. Getting back to the market share point, the new lower tax rates will particularly help the profitable retailers, potentially causing a larger bifurcation between the ‘haves’ and the ‘have nots’.
Buy Amazon Resistant Retailers, Sell Retailers Threatened By Amazon
Before we get to the tech firms, the slide below shows how much various companies could lose to Amazon in the next few years. As you can see, the dollar stores, auto parts retailers, and the home improvement centers are the retailers best able to keep Amazon at bay. Dollar stores have great prices. Home improvement firms and auto parts firms have products which can’t easily be shipped. It also takes expertise to know which auto part is needed. This expertise comes from mechanics and auto parts retailers. Food retailers face a huge risk as Amazon Fresh Direct offers low prices and the healthy selection millennials desire. The advantage of broadline retail was that you could get everything at them, avoiding multiple trips. Amazon cuts down the trips to zero, hurting their value proposition. Finally, home furnishing is hurt by the fact that physical stores are showcases. If you’re going to need the furniture shipped to you anyway, it makes sense to go look at it in person and then buy it online where you can get the best deal.
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Most Tech Stocks Not Helped Much, But Some Are Stealth Winners
The table below shows the changes tech stocks will see because of the tax plan. As I mentioned, Amazon is the biggest winner according to Bernstein. The benefit Apple sees is an accounting gain because it accrues foreign taxes, but doesn’t pay them, so they won’t see a cash flow benefit. As you can see, most tech firms see a GAAP EPS benefit in the single digits. However, the benefits aren’t just from lower corporate income taxes as some firms have substantial cash to repatriate. Microsoft and Oracle are one of those winners because they have $113 billion and $48 billion in cash respectively which they can repatriate at the low holiday rate. The stealth winners are Microsoft and Oracle because of the changing dynamics of the cloud business. These firms are shifting their revenue recognition from overseas to America because they used to make their products overseas to cut costs, but that is changing. Increasingly, the revenue recognition is in America because the data centers are here. This means the new tax rate will benefit them more in the future as their profits start to be centered domestically as the cloud grows as a percentage of their profits. Amazon might already be seeing that benefit as its cloud business is already a large portion of its profits.
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Conclusion
The stock market opened up big, but slowly sold off throughout the day. However, the sector rotation maintained throughout the day as retailers outperformed tech stocks. Both sectors don’t do well at this point in the business cycle, with consumer discretionary being one of the worst performing ones. This rally will probably be short lived for the retailers like Macy’s and Target which are getting beaten by Amazon. The tax information is affecting stocks the way a dye affects water. It slowly encompasses all trading. The most interesting part of the change is how it will affect long term competitive advantages within various sectors of the economy.
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