SINGAPORE (Aug 19): What happens when the integrity of the decision-making process of the world’s largest economy is called into doubt? Surely it must have long-term implications for the rest of the world.
Businesses can, and will, adapt to any policy shift, even if negative. But when decisions are announced without clear rationale and unrelated issues are linked only to strengthen a perceived negotiating position, they create uncertainties that are very damaging for all.
Case in point: We saw this play out again and again in trade talks between the US and the rest of the world for more than a year. Countries are at times left clueless as to how to respond to US President Donald Trump’s decisions. Businesses are holding back investments without a clear outlook going forward. This adds to the disruptions to the global supply chain and trade, all of which are weighing heavily on the global economy.
Last week, we predicted that Trump’s next tweet would send stocks spiralling higher. We were right. Markets rallied after Trump did an about-face, exempting some items from tariffs and delaying the 10% tariff on billions more worth of goods to Dec 15, from the original Sept 1.
The rally, however, was short-lived as mounting worries over an imminent global recession sent stock prices tumbling anew. The closely watched yield curve for the 10- and two-year US government bonds inverted, which historically has been an indicator of impending recession.
My Global Portfolio has done well this year, outperforming the MSCI World Net Return Index despite rising volatility. Total portfolio returns since inception now stand at 5.5%, better than the benchmark index’s 2.5% gain over the same period.
Our current strategy is to stay invested in US stocks and, in particular, consumer-related ones. In line with this theme, we added US-based low-price store operator Dollar General (DG) to our portfolio, while disposing of our shares in CIMB Group Holdings and Apple.
DG sells consumables and essential household goods. The stock has done remarkably well over the past decade, rising from US$21 at its IPO in November 2009 to the current US$133.85, for a compound annual growth rate (CAGR) of 20.4%.
DG is a proxy for the brick-and-mortar retail sector, focusing on low-middle-income households. About 80% of its products are priced at below US$5, while the remainder are priced at below US$1. Statistics show that 52.5% of the US population fall below the median annual income of US$61,000 ($84,755) in 2017. This is DG’s primary target market.
We believe DG will continue to benefit from the current low unemployment rate and wage growth that is picking up steam. Sales are also likely to be fairly resilient in the event of an economic downturn, given its low-ticket products.
The company currently operates 15,872 outlets, and growing. About three-quarters of the stores are located in towns of 20,000 or fewer people, providing convenient and quick access for rural and suburban residents to shop for basic consumables and essential household items.
Its stores generally are 10 times smaller in size, about 7,400 sq ft on average, compared with industry giants such as Walmart and Costco Wholesale Corp (doing business as Costco). This enables DG to expand quickly, employ fewer employees and recoup capital investments faster. According to Bloomberg Intelligence, the first-year internal rate of return (IRR) for a new store is about 20% on average.
DG reported 3.8% same-store sales growth in 1Q2019 on the back of higher average customer spend as well as traffic volume. This is better than the average same-store sales growth of 2.28% reported by the four retail giants: Target, Walmart, Kohl’s and Kroger.
DG is on track to adding 900 new stores and remodel 1,000 mature stores this year, to capture the needs of the underserved low-middle-income market at more locations. It also intends to shift offering mix to include more consumable items such as fresh produce, dairy and packaged foods. Sales from consumables increased from 76% in 2016 to 78% in 1Q2019.
We may see compressed gross margin in the short term since perishables are inherently lower margin, owing to short shelf life and upfront investments in fridge and refrigerators. However, fast-moving consumables are high-frequency purchases. The resulting repeat trips by customers will raise opportunities to promote other impulse purchases of higher-margin household, apparel and beauty products. According to management, a remodelled store with a fresh produce section can lift sales by 10% to 15%.
Meanwhile, Builders FirstSource (BFS) continues to do well in our portfolio, increasing nearly 30% from our acquisition cost. The company once again exceeded market expectations for the most recent 2Q2019 earnings results.
Gross margin improved 3.5% to 27.2%; adjusted earnings before interest, taxes, depreciation and amortisation (Ebitda) was up 5%, and adjusted net income rose 18% to US$74 million. The outperformance was attributed to its focus on higher-margin, value-added products such as windows, doors, millwork and manufactured products.
At the same time, BFS has gradually reduced its reliance on lumber and lumber sheet products, which command lower margins and are prone to fluctuations in commodity prices. Case in point: Commodity price deflation led to weaker lumber-related sales despite higher volumes during the quarter.
The company plans to continue investing in additional value-added manufacturing capacity, which now accounts for a larger 41% of its total revenue. The investments are justified, given the segment’s strong CAGR of 9% since 2016.
By 2023, the total manufactured products market is expected to hit US$6 billion, with upside potential, according to some market research reports. As the leading supplier and manufacturer of building materials, manufactured components and construction services in the US, BFS is well positioned to capture market share.
US total housing starts and single-family housing starts were 1.3 million and 0.8 million respectively in June. Both figures remain below the normalised historical average (from 1959 through 2018) of 1.5 million and 1.1 million respectively. The outlook for housing demand is positive, given falling mortgage rates, the ageing of housing stock and population growth.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports
