One common question both operators and investors find themselves asking is, “Which is more important, high same-store sales growth (SSSG) or high margins?” Obviously, it’s nice to have both, but that’s an increasingly difficult objective as retailers decide when to promote, how deeply to discount and what their target margin structure should be.
To shed light on this issue, we analyzed five years (2008–2012) of SSSG, margin and valuation data for 89 retailers across a variety of segments.
We found that the top 20% of retailers by SSSG saw comps grow by an average of 9.8% per year, while companies in the middle 50% saw average comp growth of 2.9% per year.
As a result, the top 20% of retailers by SSSG were rewarded by the market for their per-formance to a greater extent than the middle 50%—with annual market cap growth of 13% and 8%, respectively.
However, the performance of the top 20% of retailers by SSSG ultimately came at the expense of profits, as these companies saw flat margin growth (-0.3%) from 2008 to 2012. In contrast, the middle 50% of retailers by SSSG saw margins grow by 10% in the same period.
For example, in the department store space, Kohl’s averaged -0.5% comps from 2008 to 2012 but grew margins 5%. Still, its market cap grew at an average annual rate of 13% from 2008 to 2012. Macy’s, on the other hand, averaged 5% comp growth during the same period while its margins stayed flat, and it was rewarded with an average annual market cap growth of 49%.
Based on this analysis, investors and retailers looking to drive market value should focus on sales growth over margin growth.
In the hard lines space, Walgreens and Family Dollar are two other good examples. Family Dollar averaged 4.8% comps from 2009 to 2012 but its margin stayed flat. In that time, its annual average market cap growth was 24%. Walgreens, on the other hand, averaged 0.8% comps during the same time period, and despite its ability to grow margins 2% in a highly commoditized segment, its market cap dropped an average of 7% from 2009 to 2012.
And perhaps the best example of this trend is Amazon, which has razor-thin margins, especially on many of its media products. Yet its stock price shot up in the days after it announced its profits fell 45% in Q4 2012.
Of course, many factors influence margins, but we believe the biggest driver of increased margins for the middle 50% was an attempt to raise their average unit retail numbers and avoid responding to aggressive promotional activity. While they did just fine, those who were prepared to either hold margin levels or allow them to fall slightly while sales grew were rewarded with the most value.
Based on this analysis, investors and retailers looking to drive market value should focus on sales growth over margin growth. Flat margins and high same-store sales growth are better rewarded by the market today.
However, companies with moderate SSSG that have grown their margins may be good investment opportunities for private equity sponsors who can then begin to grow sales more aggressively and reap the market’s rewards.
8 March 2013