A couple of items of news today spelled out the dire situation of retailers with physical shops, whether they are on the High Streets, in shopping malls or out of town locations.
Firstly chocolate seller Thorntons are to close all their 61 shops and rely on internet orders and partner sales alone. Thorntons has been a feature of the retail scene for many years but it had been losing money even before the pandemic hit. I did hold the shares for a time when it was a listed company but it is now owned by Ferrero. I even sold the company some software over 20 years ago and remember visiting their factory more than once. It was indicative of changing shopping habits with supermarket sales and local convenience stores taking over from specialist shops for much of their business and with internet sales being the final nail in the coffin. Some 600 jobs will disappear as a result. The vertically integrated structure (both making and selling their products) gave them some competitive advantage but not enough.
Another indication that shoppers have changed habits, and probably permanently, was the announcement from payments company Boku (BOKU) this morning. In their results for the last year the CEO said this: “Industries dependent on face-to-face contact have been decimated. Some – hospitality, for example – will bounce back when restrictions are released, but for others, the pandemic has accelerated pre-existing trends. It turns out that many people didn’t really like driving into town to go shopping and for many types of goods the switch to online will be permanent”.
I hold some Boku shares and although revenue shows another healthy increase, it still lost money last year mainly because of a big write down of goodwill in the Identity Division. One might consider that an exceptional item, although the division is still reporting a loss.
Another interesting announcement this morning was that by Smithson Investment Trust (SSON) which I also hold. In their final results, the fund manager said this: “In the Investment Manager’s view, a high-quality business is one which can sustain a high return on operating capital employed and which generates substantial cash flow, as opposed to only creating accounting earnings. If it also reinvests some of this cash back into the business at its high returns on capital, the Investment Manager believes the cash flow will then compound over time, along with the value of the Company’s investment…….the Investment Manager will look for companies that rely on intangible assets such as one or more of the following: brand names; patents; customer relationships; distribution networks; installed bases of equipment or software which provide a captive market for services, spares and upgrades; or dominant market shares. The Investment Manager will generally seek to avoid companies that rely on tangible assets such as buildings or manufacturing plants, as it believes well-financed competitors can easily replicate and compete with such businesses. The Investment Manager believes that intangible assets are much more difficult for competitors to replicate, and companies reliant on intangible assets require more equity and are less reliant on debt as banks are less willing to lend against such assets.
The Company will only invest in companies that earn a high return on their capital on an unleveraged basis and do not require borrowed money to function. The Investment Manager will avoid sectors such as banks and real estate which require significant levels of debt in order to generate a reasonable shareholder return given their returns on unlevered equity investment are low”.
This formula of ignoring physical assets is proving very successful and demonstrates how the world is changing. I am not quite so pessimistic about real estate companies but certainly those holding retailing assets are surely to be avoided.
Roger Lawson (Twitter: https://twitter.com/RogerWLawson )
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