Retail: Theft hurting big names like Ulta, Target

Cowen Senior Research Analyst Oliver Chen joins Yahoo Finance Live to discuss the latest from the retail sector, including Costco's declining sales, the outlook for luxury brands like LVMH, and how theft is hurting big names like Target and Ulta.

Video transcript

JULIE HYMAN: Well, let's talk about another fly-in-the-ointment perhaps-- the consumer spending story. It stays in focus with results from Costco, the warehouse chain, showing it is not immune to choosier shoppers who bought fewer bulk items last quarter. Same store sales growth slowed. Back in February, CFO Richard Galanti warned investors over weakness in big ticket discretionary items, and this is a theme that we have seen across the sector in the last few weeks.

Joining us now, Oliver Chen, Cowen senior research analyst. Oliver, good morning. What a pleasure to see you here this morning. Let's talk about Costco a little bit here because we did have in particular the US comparable sales excluding fuel that did not rise as much as estimated. What's going on here? One would think that Costco could do well in this environment.

OLIVER CHEN: Julie, great being here. Happy holidays as well. So at Costco we are really excited about the continuation of exceptional value, high quality. What's really distinguished here is traffic continues to be positive at 3.5%. But what you brought up earlier, Julie, big ticket items, big and bulky home electronics, that's been a tougher negative category, and that's particularly vulnerable online as about half of those items are big and bulky.

On the other hand, food, essentials, that's working really well at Costco. We continue to love it as our top idea, Costco at large. It's actually a very simple model. In many ways it's not even a retailer. It's a membership model. And all customers are looking for value. So structurally, it's one of the best merchants in the industry. And this is one of America's few exports globally in terms of retail.

One of the big facts of Costco is they only have 3,500 to 4,000 SKUs. That compares to 200,000 plus at Walmart. Having that assortment is quite powerful, and everybody likes the Kirkland brand. That's about 30% of the business mix. That's compelling too, having that unique private label.

DIANE KING HALL: So Oliver, I got to ask you-- Diane here. So you say continues to be one of your top ideas. You also cover Walmart, so how does this compare to a Walmart? You would think that you would see kind of similar strength in Costco compared to Walmart, but it looks different to me. What's your assessment?

OLIVER CHEN: Yeah, at Walmart we're also excited by the momentum in grocery. Walmart is the US's leading grocer. It's about 60% grocery. That's a key positive. But as you think about Walmart, we think about a retail ecosystem, which means digital advertising, financial services, health and wellness. The GLP-1 drugs also helped Walmart's numbers too.

Walmart offers everyday low value. That's a core theme at Costco as well. Costco has a higher income customer. But what's happening at Walmart with curbside pickup, with the American Express deals, with Walmart Plus, they're also attracting higher income customers too. But as you know, 90% of America is within 10 miles of a Walmart, so it's very much America in terms of who it broadcasts to.

But as we think about Costco, it's a core membership model with a very fixed quantitative low markup, so you really can't get a better deal. As you think about Walmart, you think about a company that's bricks, clicks, and portals as well as a broader technology company with a very well-run grocery system as well. So we like that. And then bigger picture thematically for investors, we like what we call the bow tie thesis. So own LVMH and luxury as well as own deep value.

JULIE HYMAN: Speaking of which, you should be wearing a bow tie today for your theme, Oliver as you have I think on occasion. I am interested in that thesis, and I'm interested in what you have to say about luxury. but I got to ask you about something else first, and that is, quote unquote, shrink, the theft that we have been hearing about time and time again during this earnings season. Ulta was the most recent that talked about it, but we heard it from Dollar Tree, we heard it from Target as well. What is going on in retail America, and why does it seem like the retailers are having so much trouble stopping it?

OLIVER CHEN: Yeah, unfortunately it's been worse than expected. So as we look ahead, the plan is for more labor as well as working on fixture. And this was a big charge at Target. It was $500 million. It also led to impact of Ulta's SG&A margins. So the impact is very real.

What really needs to happen is collaboration across the government, companies, society, products. Collaboration likely needs to happen. I don't think there's an easy solution to this, and it continues to evolve. But unfortunately it's gotten worse, and it's been quite material in terms of the margins and what stores have to do largely in terms of investing in additional labor.

DIANE KING HALL: And of course, Oliver, to your point also about, say, Target's hit from this issue, Ulta has prominent placement in Target. Let's widen out in terms of Ulta. What was your overall assessment of their results this latest quarter?

OLIVER CHEN: Yeah, we've loved Ulta as a long-term idea. What we have been cautious about is peakish margins because this company has performed great. Investing in your face, wellness, that's been a long-term trend. Also cosmetics and skincare are doing great. That being said, last night was tough with the margin profile.

As you mentioned, Diane, thinking about the shrink and what it did to operating margins, that was a negative. Also we're starting to see an uptick in promotions. That's also not good too in terms of thinking about the margins. And this is also a story of a company that's continued to hold on to great gains throughout the pandemic as people really think about self-care. So we're encouraged for the long term.

But what happened in terms of expectations being very high, peakish operating margins running at 14% to 15%, as well as an attractive valuation, that caused some caution into the print in terms of how they printed relative to expectations. It's the Home Depot for women. It's a unique concept. They have a very good loyalty program.

You know, as we think about loyalty, artificial intelligence intersects very strongly with loyalty and really how much data you collect. Augmented reality is actually working in beauty as you sample different shades online as well, so we're excited about that sector at large. And the consumer puts wellness as well as beauty together. And also as we think about Gen Z, it's a very ethnic sector-- a very ethnic population. So beauty plays well into what's happening with the beauty enthusiast as well as social media.

JULIE HYMAN: And Oliver-- by the way I love that Home Depot for women analogy.


JULIE HYMAN: Let's get to the bow tie and, in particular, the fancy part, I guess, of the bow tie or what some people would call a barbell approach, the LVMH and Richemonts of the world. LVMH, such an interesting story because, of course, became the first European company to top $500 billion in market cap, but it's well below that now because of the recent route in the shares due to concerns over growth in China. Is that something that you're concerned about? Can it reattain that $500 billion in pretty short order, do you think?

OLIVER CHEN: Yeah. Health care has the number one biotech expert and health care team. We just had [INAUDIBLE] on very moments ago. The XBB variant is happening in China now, but we don't expect closures actually. So the stock's had a shock last week, but this could be a great buying opportunity.

LVMH is our top European idea. You know, you've known me for a long time, Julie. We've loved LVMH for many years. It has $10 billion of marketing spend. It's the biggest market cap company in Europe. Having that much marketing spend combined with power brands-- the Louis Vuitton brand runs at a 40% plus margin. You get Sephora which is a premier beauty retailer, and you also get Dior as well as Tiffany.

So you're getting a broad array of power brands that have reached extreme tipping points where they can spend a lot on advertising and promotion. And we've seen attractive price leverage at the high end as consumers go out again and as the Louis Vuitton and Dior brands just continue to reinvent themselves with lots of innovation. Our new creative artist Pharrell Williams joined LV as well. So all those things have-- lead to sustainable long-term growth. And he's doing a great job managing capital.

In many ways, LVMH is an asset manager of a portfolio of brands for the very long term. We're excited about that. And as we think bigger picture, the Chinese consumer, the emerging market there, it's a big important driver given that it's about 25% to 30% of revenues and 30% to 50% of growth contribution longer term. But again, at the high end, that customer is very strong. We're worried about what we call the aspirational consumer, the more entry level luxury consumer. We've seen cracks there, and that's been true in the US as well.

JULIE HYMAN: Yeah, that makes sense if we're getting all the recession talk that we have been. Oliver, always great to get your perspective. A lot of different tickers and stocks for people to keep an eye on in that discussion. Oliver Chen is Cowen senior research analyst. Thanks.

OLIVER CHEN: Pleasure being here. Thank you.