Rethinking Retail in the Age of COVID-19

As if the retail sector didn’t already have enough problems to deal with heading into 2020, along comes a pandemic.

The online e-tail revolution led by (NSDQ: AMZN) drove many small and inefficient merchants out of business. Others are still scrambling to remain alive while furiously retooling their merchandising strategies to adapt to new trends in consumer spending.

It didn’t have to be that way. The disruption caused by the “Amazon Revolution” was both inevitable and foreseeable. It may have accelerated faster than most traditional brick-and-mortar merchants anticipated, but they knew it was coming and had time to prepare. Some were too late to the game and are now paying the price.

However, the coronavirus pandemic came out of nowhere and caught the entire industry flatfooted. Stores closed overnight. Online merchants struggled to keep up with the demand for essential items such as paper towels and diapers. Supply chains buckled under the weight of millions of consumers changing their shopping habits overnight.

Before it’s over, COVID-19 may prove to be an existential threat to retailers of all sizes. Most of them are heavily leveraged, relying on today’s sales to pay next month’s rent. When sales take a sudden turn for the worse, everyone down the line feels the pain.

On May 15, the U.S. Census Bureau reported a 16.4% drop in retail sales for the month of April. That is nearly double the 8.3% decline recorded in March and a third larger than the estimate of -12.3% from a survey of industry analysts.

Coincidentally, the unemployment rate also took a bigger than expected dive in April. After a mild upward tick to 4.4% in March, unemployment ballooned to 14.7% in April. That’s its highest rate since it has been tracked going all the way back to 1948.

A Penny for Your Stock

Perhaps more so than any other business, the retail sector is divided into the haves and have-nots. Amazon’s share price has quadrupled over the past five years, while Sears Holdings (OTC: SHLDQ) has lost 99% of its value over the same span and filed for bankruptcy in 2018.

In May, upscale merchant Neiman Marcus (NYSE: NMG) also declared bankruptcy, as did J.C. Penney (NYSE: JCP). Neiman’s stock is worthless, while Penney’s trades for, well, about 18 pennies. Both companies identified the coronavirus pandemic as the proverbial straw that broke the camel’s back.

Given the huge drop in retail sales last month, you might assume that the entire sector is taking a drubbing in the stock market. Not so. In fact, the SPDR S&P Retail ETF (XRT) has rallied more than 50% since bottoming out on March 23.

You might also assume that the strong performance of the XRT over the past two months is because Amazon is its single-largest holding. Also not true. Amazon is the fund’s sixth-biggest position at 2.16% of net assets. However it ranks below lesser-known names such as (NSDQ: STMP) at 2.93%, Rite Aid (NYSE: RAD) at 2.91%, PetMed Express (NSDQ: PETS) at 2.37%, Etsy (NSDQ: ETSY) at 2.36%, and Chewy (NYSE: CHWY) at 2.35%.

That list of names is revealing, and possibly explains some of the ways in which the retail sector has changed going forward. Two of the top five holdings are companies that cater to pet owners, and another is for home crafts. While social distancing from home, a lot of people are spending money on the things that provide comfort and companionship.

Alive and Kicking

The retail sector is far from dead. Yes, many retail businesses will struggle until severe social distancing requirements have been relaxed. Unfortunately, some of them may go under before that happens. However, that does not mean that the sector as a whole will necessarily suffer. One store’s loss is another store’s gain.

I don’t pretend to be smart enough to know what consumer trends will be a year from now. What I do know is that retail spending will recover quickly once the coronavirus pandemic is over and the unemployment rate starts dropping.

For that reason, I don’t have to guess which stocks to buy to profit from a resurgence in consumer spending. Instead, I can buy a call option on XRT if I want to make that bet.

For example, last week while the XRT was trading near $41, a call option expiring in December at the $40 strike price could be bought for $5. For this trade to be profitable, XRT must appreciate at least 10% from its current price over the next six months.

Stores do not have to reopen for this trade to work. Over the past two months, everybody has learned how to shop from home. Some people are even discovering that they prefer it to the hassle of driving to the store, fighting for a parking space, and standing in a crowded checkout line.

That’s one way to make money until the coronavirus pandemic has been tamed. Another way is to follow the advice of my colleague, Amber Hestla.

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