The burden of pain
I try not to spend too much time talking about economics on the blog; I’m often reminded of the description of philosophy being a pursuit for people with ‘too much time and not enough to do with it’. The field of making predictions in economics strikes me as much of the same sometimes; in fact, I often wonder if philosophy derives more worth from its contemplative and numinous aspects. On occasion, though, I strike upon a thought which tempts me to indulge – to cast aside my better judgement and put finger to keyboard on something which does pique my curiosity about the future. Since this is an investing blog, it is – naturally – related to investment. I’ll throw my musings out there, some potential equity ‘plays’ and my esteemed readers can judge the validity of the logic for themselves.
Here’s my basic principle, then – the Internet is siphoning trade from the high street. Individuals have bought more and more of their everyday goods from the internet over the last decade, as the efficiency – and therefore cheaper prices – that online operators (like the behemoth itself, Amazon) can bring lures them away from their brick-and-mortar tendencies. I can’t remember what the first good to be bought primarily online was; it seems likely to me that it would have been something relatively homogeneous, easy to send/deliver and which requires no physical inspection on part of the buyer. CDs and DVDs seem to fit that bill quite nicely. Now people are buying groceries, celebration cards, phones, white goods… more or less everything is available on Amazon. The limit, simply, is what you feel comfortable purchasing online. Some people, understandably, want to see and touch a product before buying. Some of these people then go and shop online (a lamentable habit, as far as I’m concerned).
Either way, if we accept that the young have a higher propensity to shop online than the old – a fairly undemanding assumption – and that the overall propensity of everyone to shop online is increasing over time, as people become more comfortable with the notion, it paints a pretty bleak picture for the high street. The death of the high street, you hear people lament mournfully, usually while angrily waving their proverbial fist at one of the corporate giants of this world. That’s that, then. Where are the investment opportunities here?
Well, firstly, I feel I must at least mention the comment everyone would expect a value investor to make – the sort of stoically circumspective reflection you’d see at somewhere like the Value Perspective. What if, for a second, we consider that we might be slightly overreacting and overextrapolating? People make predictions about the imminent decline of lots of industries – and they always seem to hang in there far longer than anticipated. Furthermore, what if we’re simply conflating two trends. Sure, the high street might be in something of a long term decline as other options are opening up – but we have just had a rather deep recession, with a prolonged period of real wage declines. People don’t have much money in their pockets. Isn’t it a bit hasty to start preaching the great retail flood, washing away our shops? There’s clearly merit in that argument. I buy it – and I’d base investment decisions on it, if I wanted to, and thought a relevant high street shop was particularly cheap/interesting so as to capture my interest.
But that’s not the main focus of my reflection. Let’s assume that the high street is in a secular decline, and chew through the outcomes. High street shops doomed to unprofitability? A disastrous dis-clustering effect, as a trickle of shops leaving has a cascading outcome by reducing footfall and forcing others out of business?
I suspect not. There’s a field of study in economics around the ‘incidence of taxation’ – there are probably more closely related theories to what I’m trying to describe here, but I am alas an armchair practician of limited memory. What that analysis says – and the Wikipedia page does quite a good job of explaining it – relates to what happens when you impose a tax on a certain good or service. What happens when you put a tax on petrol, for instance, that the oil companies must pay? Surely, since the oil companies pay the tax, it bites directly into their profits? Not so. The incidence of tax falls according to the elasticity of participants in this particular market. Elasticity refers to have much quantity changes when you vary price. If you move the price lots but the quantity demanded by consumers barely moves (like cigarettes, for instance), you have an inelastic good. If you can barely move the price at all without quantity vastly changing (like fast food, maybe?) your good is elastic. Think of it (if you’re in need of prompt and simplistic reminders as I am) like an elastic band – if you have to tug lots on the price to get the quantity to move, you’re inelastic!
This is why oil companies don’t really feel that much when petrol duty is increased. Consumer preferences for petrol barely budge even as the price increases; as much as we complain, we still need to drive to and from work. Sure, we might cut a few miles off, or buy a more fuel efficient car – but it’s pretty inelastic. An inelastic demand curve means that consumers bear most of the brunt.
How is my roundabout example relevant to the high street? I realise brevity is the soul of wit – and though I might not have displayed much of that here, I’ll attempt to now. When one thinks about a market, it’s ridiculous to just think about that market in isolation. If we pencil in declines in shop profits – which we can think of as being right at the end of a very long supply chain – it’s folly to assume the ‘burden’ of that market decline will be solely borne by the shops themselves. We need to look up and down the supply chain; we need to find the parties who will share some of the burden, or take on a disproportionate amount. Whose returns will be most impacted? Suppliers? Unskilled employees providing labour, perhaps?
I think there’s a far more obvious punching bag – a group which has little choice over the provision of its services – the lessors of high street shops.
Factories can change what they produce. Employees can find new jobs. Heck, even warehouses can swap to providing warehousing for the new online businesses being set up – it’s not that fewer goods are being sold, just that online is taking market share. What has great difficulty reassigning itself, though, is a prime shop on a high street location, with price bidded up by rampant demand. These can’t be turned into houses, and the government has an enormously vested interest in keeping them open. Since it’s very difficult to change use, they face an extremely inelastic demand curve – they have to accept the market price. What’s the alternative – that you leave the shop empty for a year? This is clearly an even worse outcome.
You might argue that there’s a floor to the rents that high street landlords will charge; a minimum yield that they’ll accept. But think about this for a second – how is yield calculated? Rent / value? The argument here is cyclical, because the denominator of that equation – the value – is entirely predicated on the rent attained. If demand for high street floor space decreases, value decreases and so does rent.
I throw it out there, then – in a way which assumes no correctness on my part and leaving open entirely the possibility of someone commenting and swiftly dismantling my thoughts – that the high street might be a little more resilient than some seem to expect. And – since I promised at least a touch of relevance to my equity-loving readership, some stocks that might be affected.
What about Debenhams (DEB)? I recall they lease the vast majority of their stores, which leaves them with little downside exposure to value but a lot of potential for cheaper prices should rents fall. How many people want to rent out a massive department store nowadays? Or Moss Bros (MOSB), who equally have a large lease liability sitting in their accounts – and costs eating into profits – which might prove a hugely valuable pinata for cost reductions if rents loosen up a bit.
On the other hand, what about a company like Intu Properties (INTU (well done if you guessed that one…)) – who own many of the UK’s biggest shopping centres? Shopping centres need to be busy and need to be occupied for people to want to visit them. If shops can’t operate profitably with current lease levels, what’s better for Intu – leave the shop empty, or reduce rent demands? I’d assert that the latter is far more likely, and I’d also suggest that they’ll bear far more of the burden should the high street be in secular decline than people seem to give credit for.
This is neither a positive not a negative indictment on any of the three stocks I’ve mentioned – I haven’t analysed any of them properly, I merely chose those as potentially interesting examples to illustrate a broader point I am trying to make. My gut feeling is that the high street will be fine for a long time. Perhaps I’m just backwardly justifying that gut feeling.
Either way, feel free, as ever, to drop me a comment with your thoughts!