Which Sectors and Stocks Are Set for 2023 Holiday Sales?

We forecast that fourth-quarter total modified retail sales will rise only 3.2% this year as compared with the 6.0% increase in the fourth quarter last year. The modified retail sales metric is how we measure goods that are subject to holiday sales, bought either in a physical store or online. Our modified retail sales metric excludes categories such as automobiles, fuel, homebuilding materials, and groceries.

Breaking down total modified retail sales, we estimate that sales conducted in a physical store will only increase by 0.7%, whereas online sales will increase by 9.3%. We estimate that 31.2% of total modified sales will be conducted online this year, an increase from 29.5% last year and 12.6% a decade ago.

The rate of growth for in-store sales is expected to slow substantially as compared with 2022 when they rose 5.4%. Last year’s in-store sales were bolstered as shoppers returned to in-person shopping as the pandemic faded into the rearview mirror. Over the past five years, in-store sales growth has averaged 4.6%.

Online sales rose only 7.5% in 2022. This was not a surprise as online sales had grown at extraordinarily high rates during the pandemic years, resulting in very difficult year-over-year comparisons. Online sales growth has averaged 18.3% over the past five years.

E-Commerce

What a difference a year makes. No retailer is as synonymous with e-commerce and has been able to benefit as much from the shift to online sales as Amazon.com AMZN. Last year, in our 2022 Holiday Sales Outlook, we noted that the market had soured on Amazon, yet at that time we saw value as its stock had a Morningstar Rating of 4 stars. For the year to date through Nov. 21, Amazon’s stock soared 71% and is now firmly entrenched in 3-star territory.

Although its stock is fairly valued, we continue to see strength in Amazon’s long-term outlook as the combination of its e-commerce platform, Amazon Web Services division, and its advertising sales will lead to an average 16% growth rate in earnings over the next decade. For the fourth quarter, we project Amazon’s online sales will increase by 7%, its advertising will grow by 20%, and AWS will expand by 13%.

While Amazon continues to drive sales and take market share, eBay EBAY expects its fourth-quarter earnings to be down 2% to 6% as total sales across its platform are expected to be flat to down 2%. But we think this tepid near-term performance is overshadowing a longer-term turnaround that we expect to take hold.

EBay recently rolled out a new app experience that allows users to more easily post new listings with an improved appearance. We expect this will boost sales by both increasing the number of listings on eBay’s site and making those listings more attractive to potential buyers. While eBay’s sales are under pressure in the fourth quarter, they may rebound in the first quarter as sales are typically driven by users looking to resell gifts that they don’t want. EBay may also benefit from the inflation squeeze on lower-income households, which may look to both monetize used goods as an additional income stream as well as look to purchase used goods to save money.

We also think that eBay’s long-term potential for its advertising business is underappreciated by the market. In our view, eBay is still in the early stages of building its advertising prowess. We think this area has the potential to increase its operating margin as a high percentage of advertising revenue drops right to the bottom line.

Source: Morningstar. Data as of Nov. 21, 2023. Prices in USD

Electronic Gaming

Spending on video games this holiday season will likely be similar to last year, as the current Xbox and PlayStation console cycles are well established and few major titles are set to release. Overall, consumers continue to migrate to more recurring gaming purchases.

Electronic Arts EA indicated that its perennial sports blockbuster Madden 24 has performed well, with bookings up 6% versus the prior installment, while the firm’s total North American bookings during the calendar third quarter were likely roughly flat. Roblox RBLX has also seen steady bookings growth in the United States as more people spend time on the platform and spend Robux, including older players with more disposable income. With Take-Two’s TTWO Rockstar Games announcing that the first trailer for Grand Theft Auto 6 will debut in early December, gamers may hold off on major purchases in anticipation of a 2024 release.

Source: Morningstar. Data as of Nov. 21, 2023. Prices in USD.

Toys

Unfortunately for the kids, it looks like the Grinch will have his way in the toy category this year. We forecast 2023 will be the second down year for toy companies as are retailers not taking much inventory this year after resorting to deep discounting at the end of the holiday season last year.

The good news is that after suffering supply chain disruptions over the past few years, there won’t be as much inventory buildup that will require a deep discount to clear up shelf space after the holidays. This should set up a more normalized restocking pattern for next year.

Of the two major toy companies, Mattel MAT has substantially outperformed Hasbro HAS this year as investors are expecting the Barbie movie to provide a strong tailwind for its synonymous franchise this year. As such, Mattel stock is only trading at a 24% discount as compared with Hasbro, which trades at a 49% discount to our fair value.

While Hasbro trades at a deeper discount, it has several moving parts that investors need to digest before investing in this deep-value play. Hasbro is in the midst of divesting its entertainment division, which currently accounts for approximately 14% of total revenue. This divestiture should help Hasbro clear up its outlook as the entertainment division has been a low-margin, volatile part of the business. For example, the Hollywood writers’ strike will take its toll in the fourth quarter, and we project this division’s revenue will drop by 30%.

Source: Morningstar. Data as of Nov. 21, 2023. Prices in USD.

Retailers

Expectations are low across the broadline retailers this year as inflation, high interest rates, and the resumption of student loan repayments are expected to take a toll on sales. Yet, even with these lowered expectations, we think the greater risk remains more to the downside than to the upside. On recent earnings conference calls, several management teams mentioned that they had seen a slowdown in sales in October compared with what they had expected.

The good news is that inventory levels are in better shape this year compared with last year. With inventory levels where the retailers want them to be, we think there will be less promotional activity required to move the merchandise than there was last year.

While many of these stocks are already trading at very depressed levels compared with our valuations, we suggest caution as these same companies also have Very High Uncertainty Ratings. An Uncertainty Rating reflects our assessment of the dispersion of future outcomes for the intrinsic value of a company and those factors that can affect our ability to accurately predict these outcomes.

A Very High Uncertainty Rating means that we expect a wide dispersion of outcomes regarding our long-term intrinsic valuation. As such, these types of stocks can be very volatile to both the upside and downside. As recently covered with Canadian Tire CTC.A in Canada, retailers with physical locations are not only feeling the pinch of subdued consumer spending, but pressure from online retailers.

Source: Morningstar. Data as of Nov. 21, 2023. Prices in USD.

Specialty Retailers

The worst of the pandemic may well be behind us, but the disruptions it caused are still working their way through the retailers that we cover. This has led to a number of distortions, resulting in specialty retailers being some of the more interesting opportunities this holiday season. In many cases, we think the market is overly focused on near-term issues and not the long-term intrinsic values once those distortions normalize over time.

For example, to a large degree, Best Buy BBY is still being affected by a pull-forward effect during the early days of the pandemic. PC sales and other work-at-home electronics skyrocketed early during the pandemic as office workers needed to quickly build out their home office. Appliances and other home furnishings then took off as many households remodeled or looked to move out of urban areas and into suburban environments. Lastly, mobile phone sales took off as pandemic-instigated stimulus checks provided the funds for consumers to trade up to the latest cellphone models. Best Buy stock soared in 2020 as the market overestimated how long these high sales trends would last as these trends pulled forward a significant amount of future demand from products that have long lives.

In the short term, we think Best Buy’s sales will remain under pressure until the refresh cycle for PCs and cellphones begins to reemerge as these products age. However, the stock has already priced in that cycle, and after falling back to prepandemic levels, it is now trading at a 29% discount to our long-term valuation. While it may take some time for the market to acknowledge the long-term value once the sales cycle begins to pick up, we think the stock will be supported by its 5.3% dividend yield and its share buyback program.

Another example is Chewy CHWY, the largest e-commerce petcare retailer in the U.S. Following the emergence of the pandemic and as lockdowns were put in place and social distancing became the norm, the number of households with a new pet soared to fill that social void. Growth at Chewy initially soared, as those new pet owners turned to Chewy to feed pets and buy crates, toys, and accessories.

What we have found is that pet owners are a loyal bunch, and Chewy has earned their loyalty over the past few years. This is evidenced by Chewy’s sales base, of which 75% of revenue is generated by its subscription business. The sales growth rate has slowed this past year as fewer households brought new pets into their lives. We think we are now starting to get to the point where the growth rate for households with pets should begin to increase back to historical normalized levels. In our view, Chewy remains a growth business that is not recognized by the market and should continue to benefit as pet category sales move increasingly online.

Etsy ETSY is an online retailer that specializes in home furnishings, crafts, and gifting for special events. Etsy’s sales were bolstered early in the pandemic as consumers were either unable or unwilling to shop in public and shifted their buying patterns to online shopping. This growth rate has slowed, but we think the market is overlooking the long-term potential for this specialty online retailer.

Exemplifying the high degree of uncertainty surrounding the amount of consumer spending this holiday season, Etsy provided a relatively wide range of guidance for sales on its platform, from being down by a mid-single-digit percentage to up slightly. While Etsy’s middle-income consumers are under increasing pressure from inflation, its higher-end customers appear to remain well positioned, as those customers increased spending by 20% per buyer during the most recent quarter.

Do too many investors still confuse Bath & Body Works BBWI with bankrupt Bed Bath & Beyond? It’s one possible explanation as to why this stock trades at one of the largest discounts to fair value across our coverage. We expect that even in a more challenging retail sales environment, Bath & Body Works should be able to hold its own. Its product portfolio specializes in items that consumers consider affordable and gift-worthy, with accessible price points for all income levels.

For investors with a longer time horizon, we expect that product innovation (in existing and new categories) and productivity gains of new store formats will lift Bath & Body Works’ top- and bottom-line performance over time. Furthermore, gains from omnichannel improvements (buy online/pick up in the store, for example) should remain a mainstay, while other digital enhancements support both conversion and profit upside. Lastly, we expect that benefits from its recently revamped customer loyalty program will drive greater engagement and repeat customer sales growth.

Source: Morningstar. Data as of Nov. 21, 2023. Prices in USD.

Luxury

Is the North American consumer’s appetite for luxury brands getting close to being tapped out? This is the question we have been asked most recently, and anecdotal evidence seems to confirm that assertion. For example, in its recent earnings report, Burberry noted that demand in the Americas remained weak this past quarter with a 10% decrease in comparable store sales—a sequential deceleration from negative 8% in the prior quarter. Yet, it’s not just a concern about demand from the U.S. consumer but also internationally. Burberry noted that comp store sales in Asia also dropped 2% last quarter.

Consolidation is shaking up the luxury market in the U.S. In August 2023, Tapestry TPR announced that it agreed to acquire Capri CPRI—and the market did not react kindly to this merger, sending Tapestry shares sharply downward. However, while the market is concerned that Tapestry is overpaying and questions the strategic rationale, we think the transaction will be accretive over time.

The combination of Tapestry and Capri will bring together several brand portfolios, including Coach, Kate Spade, and Michael Kors. We think this will provide additional operating leverage, but we also expect that Tapestry’s management will be able to better drive revenue growth in some of Capri’s other brands. For example, Versace and Jimmy Choo both have high brand-name recognition, yet that awareness has not developed into a meaningful revenue base. We think that Tapestry will be able to drive higher revenue growth in both of these brands. However, this will not be an overnight story and will take at least several quarters before we might see meaningful results. Considering the transaction is not expected to close until next year, it might not be until after next year’s holiday season that we start seeing the benefits.

In the near term, management has its work cut out to assuage investor concerns that it overpaid and defend its strategic rationale.

Source: Morningstar. Data as of Nov. 21, 2023. Prices in USD.

REITs—Shopping malls

Finally, we think the death of the shopping mall has been greatly exaggerated. Shoppers continue to value the in-person shopping experience, and malls have continued to evolve to become more experiential and less reliant on retail sales.

Class A malls (the highest quality) have worked to refine their portfolios of stores. By using alternative data such as cellphone locations, malls can measure which stores get the highest amount of traffic and which stores get consumers to stay in the longest. Malls can also use this data to see which stores have the highest crossover consumer appeal.

Malls have also evolved to incorporate more experiential offerings. Experiential offerings are those that cannot be recreated online, such as restaurants, gyms, physicians’ offices, and other services. These offerings are not only a way to compete against online sales but also change malls into lifestyle centers and drive foot traffic.

Source: Morningstar. Data as of November 21, 2023. Prices in USD.