People infected by COVID reacted to it in different ways. Some had such mild symptom that they were hardly aware of them, while others became severely ill. Interestingly, industries that were impacted by the virus also reacted very differently.
Both tech companies and grocers benefited from the pandemic. Some techs enjoyed a big spurt in profits and they not only rose but led the market higher. The stocks of some grocers also enjoyed much higher profits, however their shares shrugged off that growth and trended lower. Why were investors so bullish about one group that benefited from the virus yet pessimistic about the other? Taking a closer look at them gives a fascinating explanation.
The Favorite Few
Techs that benefited from COVID include the FANG stocks (Facebook, Apple, Netflix, Microsoft, and Google) and are among the biggest companies not just in America but in the world.
These companies grew their EBITDA by an average of 9%, yet the market drove their shares up by an average of 52%. EBITDA is an abbreviation that stands for earnings before interest, taxes, depreciation, and amortization. It is a financial measure used to gauge a company’s efficiency and to compare it to that of other companies. FANG stocks trade at an average of around 30x EBITDA, which is a high multiple.
Analysts suggest several explanations for the bullishness. According to Zero Hedge, “investors believe that the tech companies’ 2020 growth represents an acceleration of a long-term trend, rather than just a one-time windfall profit.” Therefore, they increased their valuations.
A recent article in the Wall Street Journal had a different theory. It suggested that COVID has forced companies to modernize and thereby become more efficient. “COVID has acted like a time machine: it brought 2030 to 2020,” one executive at Shopify told the Journal. “Trends that were unfolding slowly ... accelerated rapidly.”
The Group Not Favored
As a group, shares of grocery stores are not the most exciting; they never develop breakthrough technologies, nor do they produce exciting new products. And speculators hoping to double their money quickly usually don’t focus on the grocery industry. Rather, grocers have more appeal to investors who are patient and seek safety. The fact that the population is growing and that people always need to eat, regardless of whether the economy is booming or in recession, is also reassuring to them.
Despite this logic, the 2010s were a difficult decade for US grocery chains. Always a competitive business, the pressure intensified as some European discounters perceived opportunities in America and entered the US market. There were other problems, too. Grocery chains, already trying to cope despite thin margins, were rocked by Amazon’s purchase of Whole Foods. And as if these challenges were not enough, employees at some grocers decided to unionize, increasing their overhead. Some small players like Dean Foods were forced into bankruptcy.
When COVID came on the scene it appeared to be exactly what the industry needed. Fearing the virus would lead to shortages, consumers stocked up on basic foods and related items. Grocers benefited significantly from all the panic buying, and their financials improved.
“Over the past twelve months, EBITDA is up about 40% on average for publicly traded grocery chains,” Dan Rasmussen wrote on Verdad Capital. Weis Markets did slightly better than that average, while chains like Ingles Markets and Albertsons did significantly better.
Grocers put their COVID-related higher profits to good use. They reduced debt by a combined total of approximately $4 billion. They also reinvested some of their profits in new technology and upgraded their capabilities to work more efficiently with grocery delivery businesses.
One would think that the huge spurt in profits, improved technology, lower debt, and increased efficiencies would generate investor enthusiasm, but they did not, and grocery stocks disappointed. Of all the stocks in the group, Weis Markets alone beat the popular market indexes.
The question begs to be asked: Why have grocery chains been so unpopular despite the big jump in their profits in 2020? And why were they not treated with the same respect and enthusiasm the FANG stocks were accorded?
According to Rasmussen, the explanation is clear. “Investors are not convinced that a one-time spurt in profits will make a material impact on these firms’ valuations. They think comparisons made next year will be negative, that these firms will be left with razor-thin margins and will still be afflicted by the same litany of problems they had in the 2010s. That’s why investors value the future income stream of these companies at significantly lower valuation multiples today than 12 months ago.” In other words, while 2020 was an unusually good year for grocers, it is perceived to be more of a one-time gain than the start of a new trend.
Down But Not Out
Despite having been battered by investors and their long list of problems grocers in particular and retailers in general still have some friends in the investment world. Gavin Baker, a former portfolio manager at Fidelity, is one of them. Baker follows growth stocks and believes that COVID had a positive impact on retailers like grocery stores. He argues that Amazon’s acquisition of Whole Foods (their largest ever) has made clear that even these days retail is valuable.
“There’s a strange belief in certain circles that the future will be e-commerce only and that brick and mortar stores have no value,” he says. “This is strange because the world’s largest, most sophisticated e-commerce companies are all opening stores - lots of stores.” Amazon opened dozens of ‘Amazon Go’ stores in 2019 and already has or soon will be opening up to 3,000 more in the US alone. And those include multiple store formats including Go, Whole Foods, Book Stores and others.
In his 2017 letter to shareholders, Jack Ma, the head of Alibaba (China’s version of Amazon), wrote that ‘Commerce as we know it is changing in front of our eyes. E-commerce is rapidly evolving into ‘New Retail.’” Alibaba is rapidly opening several store formats throughout China and other companies are also opening new stores in both China and the US. Among the retailers opening new stores in the US are At Home, Five Below, BJ’s Wholesale, Burlington, and Old Navy. Discount grocer Aldi opened more than 70 stores in the States last year.
There’s no doubt that grocers and other retailers face significant challenges going forward. However, having survived fierce online competition, tapped out consumers and lockdowns, among other serious challenges, many retailers have become more efficient and also have strengthened their e-commerce businesses. Moreover, some of the industry’s largest and most successful players see a bright future and are putting their money where their mouths are. All things considered, reports of the industry’s death are premature.