Retail Real Estate Stocks Scares Me

The real title of this post is “Is the market under-pricing technology obsolescence risk?”. Which is probably the most boring title I have ever written. So I went with the flashier title you see, because I think I am on to something worth pursuing here.

In my last post I laid out a theory that the Stock Market is mis-pricing the risk of a company missing a product cycle and becoming obsolete – hence technology obsolescence risk. I won’t get into all the mechanics, it gets drier than the headline, but I now have this theory that the stock market is penalizing certain companies with too high a risk of going obsolete. (And under penalizing those that are already over the shark.)

I am trying to figure out a way to prove that, but it requires a lot of data. (One person did offer me access to their FactSet feed and it is taking me a long time just to compile the right query.) I think that if we could assign a measure of tech risk to a stock, we could build a better index of technology stocks, that would outperform any index that included all those out-of-date companies.

Then I went for a drive in the desert.

In particular, I visiting family in the High Desert of Los Angeles. Unlike the rest of Southern California, the town of Lancaster knows that it is a desert – windows are tinted, stores are heavily air conditioned. And one day, when it was 90+ degrees outside, I ran some errands and visited a bunch of big box retailers – Toys ‘R Us, Best Buy, etc. And they were all empty. This was the week before Easter, which has apparently become a big toy- and gift-giving holiday. Despite being veritable oases of air conditioning, almost no one was shopping.

I had to think that as climate controlled as those stores are, an even better strategy for shopping in the desert is to make heavy use of Amazon. (Disclaimer: I own 100 AMZN shares.)

Now, I do not follow retail or real estate stocks much. And I am aware that investors in those sectors fully appreciate the risk that Amazon and Internet retail pose to the broader market. But I have to wonder, if even tech investors have a hard time pricing the risk of obsolescence, it must be much harder for investors who do not see that much in their area of expertise.

The thing that always surprises me in tech is that when a company falters, it fails very quickly. I mentioned Nortel last post, but think of Motorola, Nokia and Blackberry. All went from top of the heap to the bottom in under eighteen months, once things turned. Could we see something similar in retail? My guess is that retail investors are already familiar with this sort of problem – Radio Shack being just the most recent failure.

But what about real estate investors? I am sure real estate investors are aware of the Internet and the fact that it can hurt many potential tenants. But is that risk truly reflected in real estate stocks. I have to think it is not.

This train of thought was reinforced recently when I spoke to the channel manager for a large electronics OEM. Apparently, his team had recently conducted a large review of retail trends, forecasting out the landscape five years from now. His conclusions were sobering. His team is now taking big steps away from relying on distribution through physical retailers. He was incredibly downbeat about the future for electronics retailers. His view was that the Amazon and the other e-commerce players were lightyears ahead in their ability to use data to drive sales, and were only just scratching the surface of what they can achieve. This did not sound too promising for physical retailers.

Again, I think many investors are aware of this trend. But I think they are going to miss two things.

First, the transition away from physical retail is accelerating and will likely come sooner than many expect. In the technology industry we are accustomed to the notion that things move very quickly, and the risk of corporate death are high. This is not true in other industries, and it is easy to overestimate the amount of time remaining.

Second, this problem extends way past electronics. Home Décor, collectibles, food and most important – clothing. I spent some time in the Desert Mall as well, and by my rough math, 85% of the stores there were exposed to growing Internet distribution. People still like to try on their clothes before buying them, but that is very much a cultural preference, which is fading. For years everyone assumed that categories like luxury goods would be immune to Internet shopping, but Richemont’s acquisition of Yoox last week means that even that sector is in play.

What will happen to all the malls and big box retail shells ten years from now? I am sure that physical retail itself is not going to become obsolete. Teens everywhere will always want to go hang out at the mall. But I have to imagine that physical retail sales volumes are going to shrink to the point that many physical locations will have to close. And there is the very real risk that this happens faster than anyone is currently expecting.

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