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Top Consumer Industry and Commercial Real Estate Themes for Q1 2023

RJ Hottovy
Mar 31, 2023
Top Consumer Industry and Commercial Real Estate Themes for Q1 2023

Each of the past several years in the retail industry have been defined by a key theme. 2020 was a year of survival, as COVID brought unprecedented challenges and opportunities for adaptation for retailers and restaurants, regardless of size or channel. 2021 was a year of adjustment, as retailers had to adjust to changes in the way consumers interacted with them amid evolving working situations and migration shifts. 2022 was shaping up to be the year that retailers made changes to their physical stores and online sales platforms based on the changes in consumer behavior, but naturally, the year brought more changes as the compounded impact of inflation across several key necessity categories (food, gas, rent, healthcare) changed behavior, the rapid shift from pandemic consumption to reopening consumption left many retailers with way too much inventory, and construction costs/labor availability issues made retailer expansion plans more challenging.

With one quarter of the year in the books, we thought we’d look at what narratives are beginning to emerge as the key themes for 2023. Finding a central theme isn’t easy, especially when we see a wide range of visitation trends across retailers in each category. That said, based on the analysis we’ve presented thus far in the Anchor this year and additional commentary from senior retail executives presenting at this week’s Shoptalk event, it appears that 2023 is shaping up to be the year of physical store optimization, with retailers using their stores in ways that they’ve never done before to maximize returns. In a year of rising interest rates and more costly customer digital customer acquisition costs, it’s apparent that physical stores have become a way for retail and other consumer brands to acquire new visitors and engage with new customers. Below, we’ve summarized the key themes that retailers, restaurants, commercial real estate executives, and investors should be aware of as we continue to look to the rest of the year.

Consumers are Price-Sensitive, but Will Continue to Spend on Newness and Innovation

This year, we’ve highlighted several examples of where value-oriented retailers are outperforming more discretionary categories, although the real breakthrough stories in retail and restaurants in 2023 are those players that can combine value with newness and innovation. This is easier said than done, but we’ve highlighted a few retailers that are driving outsized visits to their stores using this engagement with customers to maximize the effectiveness of their physical stores.

For example, Target CEO Brian Cornell pointed out on the retailer’s Q4 2022 update that, "value is absolutely top of mind right now, being able to deliver affordable joy, differentiates us in the marketplace." For 2023, Target is going to put more emphasis on “deepening customer connections” and less on “acquiring new customers,” with Chief Growth Officer Christina Hennington stating, “Over the last couple of years, we've gained a tremendous amount of new guests into the Target ecosystem. Our focus right now has been to deepen our engagement with the guests. Of course, we always want more guests, but the opportunity in front of us is much more to convert them into using the suite of capabilities because they become much more loyal. They understand the Target value proposition more deeply once they experience the ease and convenience of Drive-Up or once they recognized what an incredible food and beverage offering we have. That's our primary focus right now.”

This past week at Shoptalk, Target CFO Michael Fiddelke reiterated this viewpoint, ““The thing that I think is most remarkable, and I would’ve gotten this wrong before we launched drive-up, is that when people engage in different ways of shopping, your spend at Target increases meaningfully in total, and also your store spend goes up too,” Fiddelke explained. “It’s just such a deepening of the relationship with Target when you make it easy for guests to shop however they want.”

Like many other retailers, Target’s customers are price-sensitive, with Fiddelke noting that its shoppers are responding more to promotions and cutting back on more discretionary purchases. However, consumers are still visiting Target stores because of investments in new merchandise, new experiences and faster delivery (including expedited product shipping as well as expanded same-day delivery and pickup options). Target’s outperformance relative to its peers is evident in the YoY visitation trend chart below.

We’ve seen other instances where differentiated merchandising and effective promotions are equally important for driving visitation trends. Five Below reported a comparable store sales increase of 1.9% for Q4 2022, which was ahead of the high end of its guidance calling for a 1% decline to a 1% increase. Management attributed the outperformance to “WOW” merchandising efforts (stocking unique products in a “treasure-hunt” environment), though easing supply chain constraints and more targeted marketing efforts also played a part. data indicates a 1% decrease in visits per location during calendar Q4 2022, which we believe is consistent with the reported figures when combined with modest pricing increases and ongoing remodels to the Five Beyond store format (which features items priced above its $5 price point). Impressively, these figures compare favorably to Dollar General’s pOpShelf,  which has seen a moderation in visits per location the past several quarters.

Five Below’s visit per location trends are notable as the company looks to open 200-plus stores in 2023 and convert another 400 locations (30% of its existing store base) to its Five Beyond format. Looking ahead, Five Below and its innovative value approach appear well positioned to capture visitation share from Party City (which recently filed for Chapter 11 bankruptcy) and Bed Bath & Beyond (which announced a $300M stock offering yesterday and acknowledged “it will likely file for bankruptcy protection” if they do not “receive the funds from offering" according to the stock offering registration statements).

Inflation May be Moderating…but it is Still Driving Changes in Consumer Behavior

Inflation may be moderating, but inflation for groceries has remained higher and for longer than many industry executives have expected. The high rate of food at home inflation is depressing sales for many retailer’s discretionary merchandise assortment, which carry higher margins. As such, it’s not surprising that Walmart in 2023 is "dedicated to helping people save money and live a better life. That's who we are," per CEO Doug McMillion. They will do so by "increasing the grocery mix to entry price points and better value for its owned-brands." This will cost them gross margin rate, which will also give them license to "request" that dry grocery vendors similarly take margin hits.

Not surprising, numerous news articles have begun to circulate about grocers “leaning on their suppliers to cut prices and capitalize on cooling inflation – and prevent shoppers from…turning to discount stores,” as read a recent article in The Washington Post. We've previously noted that an inflection point for packaged food was looming, as well as was a concerted effort by grocers to sharpen the value of their private brands as a strategy to distinguish their offering (at the expense of national brands’ share-of-stomach).

With respect to Walmart’s view regarding the health of the U.S. consumer, McMillion called out that, "[Consumers are being] choiceful, discerning, thoughtful. I think you can see it in the mix impact. Customers are still spending money…[but they are] making choices." As we have written in the Anchor over the past month, spending growth at restaurants and out-of-home has been building, although some of the growth is due to higher prices that chains have implemented due to inflation (restaurant visits remain down on a YoY basis). To accommodate that discretionary services spending, consumers are “making choices” to not spend on discretionary goods (which had grown ever higher over the past three years and which is now normalizing).

Similar to our discussion of dollar stores and non-discretionary retail categories a few weeks ago, one can see how traffic is bifurcating in the chart below between discount and conventional grocers. Over the past year, conventional grocers have been able to drive outsized gains in their top lines and "penny profit" (selling price less merchandise cost) because grocery prices were up double-digits. However, with inflation expected to ease to +3 this year (per the U.S. Food and Drug Administration), conventional grocers need to stabilize traffic (versus the running mid-single-digit decline) for comp-store sales not to contract. Given the low margin rates in grocery and high fixed costs, contracting sales and penny profits can quickly eviscerate margins and profits. Grocers demonstrating greater private brand value is a way to drive traffic and penny profit. 2023 is going to be a difficult year for food retailers and manufacturers.

Store Service Level Investments to Secure Customer Loyalty

Higher store and service standards was one of our themes for retail in 2023 and beyond, and one of the key ways that retailers are looking to optimize their store assets. As retailers reported their Q4 2022 results, we saw a large bifurcation between those that were in an advantaged position to invest in those levels from those that didn’t across price points and categories. Moreover, those that can are pressing their advantage in 2023, including at Macy’s, Anthropologie, Home Depot, Target, and many, many others.

Foot Locker's Mary Dillon provided one of the keynote addresses at Shoptalk this week. In addition to reshaping the company’s store portfolio (which we discussed last week) and working toward a goal of 50% off-mall locations by shedding Class C and D mall locations, Dillon spoke about the importance of investing in store teams, noting that they were the key to creating trust among consumers and driving greater loyalty.

The importance of increased service investment also originated as we saw 2022 and 2023 as years where the pendulum would swing back in favor of bricks & mortar from digital, including from the consumer, unit economics, and the cost of capital. Warby Parker’s story over the past two years is one example (from many) of this. In the Warby section below, we point out the company’s change in focus for 2023 with management deciding to reduce the investment and size of the digital business which allows them to invest more to grow the bricks & mortar business, which implies that management views investing in the physical as producing a superior IRR to that of the digital business. (Recall that Warby was once considered the most successful digitally native brand.)

Off-Price Retail Remains in “Chase-Mode”

We see many of the same themes that we reported on and in our Holiday 2022 & Beyond Outlook in the Q4 2022 updates for the off-price retailers. Those themes include: (1) the rising appeal of “value” for consumers and the reappearance of the hourglass consumption pattern resulting from the disengagement of middle–income consumers; (2) the importance of “surprise and delight” in merchandise (which is where off-price can especially win given the plentiful buying environment); (3) the importance of convenience and physical stores to an off-price brand’s ability to win consumer consideration; (4) heavy discounts to get “clean” of excess inventory brought consumers into the stores; and (5) for management teams and investors, obtaining a clean inventory position going into 2023 was the goal for Q4 2022. Lastly, from all of these reports, one can say that "inflation" for apparel, shoes, accessories, and soft-home is comfortably in the rearview mirror.

Some Restaurants Adjusting to Consumer Behavior Changes Faster than Others

We still see 2023 being a “winners and losers” year for much of the restaurant industry. We’ve previously discussed that many operators were optimistic heading into the year because of adjustments in store layouts to better accommodate changing consumer behavior coming out of the pandemic and enhancements to digital marketing/loyalty programs, but also acknowledging that persistent inflation and new store construction delays and costs were likely to dampen results somewhat through at least the first half of 2023.

Because of the significant changes brought about because of the pandemic compared to the rest of the retail category, restaurants in particular remain eager to apply the learnings from the past several years and maximize returns on their physical store assets (especially against a rising interest rate backdrop). This includes new business models designed to make their restaurant locations more efficient and potentially unlock new markets for growth (including digital ordering, expanded off-premises capabilities, and pick-up windows). Many restaurants have noted that the labor market–something that had created high turnover for many restaurant chains in 2022–had stabilized somewhat (especially at the store manager level), but that restaurant construction remains a challenge (citing 20 higher pre-opening costs per location and new restaurant openings being pushed into late 2023 and 2024).

It’s early in the year, but it’s becoming evident that some operators are further along in efforts to refine their business models and adapt to changes in consumer preferences. Earlier this year, we discussed how McDonald’s was one of the operators separating itself from the pack due to improvements in its loyalty program that are helping to drive greater visit frequency. We’ve also seen chains like Chili’s and Chipotle acknowledge that increased menu prices would likely impact visits, but also potentially improve profitability as it shed the number of guests that are heavily dependent on discounts to make a purchase (less profitable transactions, in other words).

Looking at current category visitation trends, QSR and fast casual chains have continued to outpace the full-service dining (below). We’re still seeing some signs of trade down among full-service restaurant visitors, despite still heightened demand amid the continued shift away from physical goods to services.

E-Commerce Will be Challenging in 2023

2023-to-date commentary from several online retailers add credence to our view that pure-play e-commerce will remain a single-digit growth category forever more. The U.S. Census Bureau reported that all-in e-commerce (both the pure-play and omnichannel retailers’ e-commerce businesses) grew +6.2% in Q4 2022 on a year-over-year basis, down from +10.7% in Q3 2022. (Q3 2022 would have been +8% without the shift of Amazon Prime Day from May to July.) The trend is shown in the table below. As one can see for the 2019 period, growth was already beginning to slow with the best trailing-twelve-month (TTM) period from a dollar growth perspective being Q4 2019 at $22B. If we apply Q4 2022’s trailing-twelve-month dollar growth rate to each of 2023’s quarters, their rate of growth averages +7%; the same rate that we’ve seen in the Monthly Advance Retail Sales report thus far in 2023. While the supplemental estimates from the e-commerce report show that Q4 2022’s growth was held back by 200 basis points due to a large -26% YoY decline in consumer electronics, adding that back still only gets one to +8% growth. Pure-play e-commerce retailers were 59% of Q4’s $299B in volume and omnichannel retailers were the remaining 41%. The e-commerce channel for omnichannel retailers was down slightly YoY as customers returned to the store.

Consolidation and Rightsizing Wave on the Horizon?

2022 was a tough year for certain retail categories that saw a pull-forward in demand due to the pandemic, including consumer electronics, home improvement, and home furnishing retailers. With rising mortgage rates, slowing home sales, broader inflationary headwinds, these categories were among the weakest-performing categories among discretionary retail with respect to year-over-year visitations in 2022. The start of 2023 saw the home furnishing and consumer electronics categories narrow the gap with other discretionary retail categories, but also benefited from inventory clearance events that we’ve discussed in recent weeks.

Against this cautious backdrop, where do these categories go from here and what does it mean for the commercial real estate market? We believe some of the categories that are seeing a normalization in demand will likely follow the department store category, where we’ve started to see consolidation and a movement to explore smaller format stores/showrooms. This includes Bed Bath & Beyond's store closure plans and other players following Arhaus' lead with smaller-format design studio formats. has already taken a detailed look at the ongoing trend of store fleet optimization and the benefits of smaller format stores across other categories, but we expect this to be a more active discussion topic in the coming years for retailers in these sectors.

Harnessing New Ways to Maximize Store-Level Returns

Driving increased visits isn’t the only path to optimizing physical stores, so we would expect retailers to continue to look for other ways to drive store economics higher in 2023. Placer has discussed the significant opportunities that retailers have on the retail media front in the past, and it was evident from discussions at this week’s Shoptalk event that this remains a key way that retailers (and potentially restaurants) will look to generate higher returns on their physical and digital assets in the future. Although there have been fewer announcements as of late, we still see store-in-store partnerships as opportunities for retailers and retail brands to expand audience reach, fill holes in product assortments, elevate the in-store experience, and improve in-store economics.

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RJ Hottovy

Head of Analytical Research,

R.J. Hottovy, CFA has covered the restaurant, retail, and e-commerce sectors for 20 years as an equity analyst and strategist for Morningstar, William Blair & Co., and Deutsche Bank. R.J. also brings a wealth of experience with early-stage investments as a committee member for the IrishAngels / Vitalize venture capital group. Over the past three years, he advised over 50 food service companies on more than $200 million in early-stage capital raises and M&A transactions.

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