Stocks finished mixed yesterday. But the real message came after the close. Salesforce.com beat earnings forecasts by a huge amount. Despite its high price, its shares surged about 8% in late trading. Toll Brothers# also had a great quarter, leading to a 3% gain in late trading. On the other hand, Nordstrom, which has been a true victim of the pandemic, saw its shares fall further after missing sharply reduced expectations. At the same time, Urban Outfitters, another retailer that should have been in the same boat, rose sharply after hours on better than expected results. It did a much better job than Nordstrom, reaching its customer base online to offset some of the damage from mandated store closures.
It may seem hard to put this all together but it isn’t. Covid-19 has changed the world we live in. Those that adapt not only survive but flourish. Salesforce sells customer fronting software, products needed to get companies closer to their customer base. Without physical presence, getting in front digitally is critical. Salesforce had the right set of products going in, and moved quickly to make its product set even more robust. The payoff was a great Q2. Nordstrom was considered the most forward-thinking digital company among the department store set. Although it may have had the tools in place, its digital sales were down 5%. You would think, with so many stores closed, that Nordstrom could at least move its customers to digital. Yesterday we heard from Best Buy, who noted that digital sales in the July quarter were up over 200%. Thus, while Nordstrom had the platform in place, it was unable to drive customers to the platform. Not only is that startling (as in startling bad), but it is a condemnation of the whole department store complex. While the chains may think they are moving to the digital world quickly, they are simply losing share dramatically. The fact is that customers are leaving and many will never return.
On the other hand, companies like Salesforce, Urban Outfitters and Toll Brothers are gaining share. In the case of Toll Brothers, demographics matter. Young millennials who now have children of school age are moving to the suburbs. Empty nesters want less space yet want an active environment. Toll Brothers has the advantages of capital, available land, a big web presence, and physical presence in the right places, courtesy of land purchased years ago. Indeed, all the major national homebuilders share the same advantages.
As I have mentioned many times, pandemics accelerate change and reward companies quick to adapt. GDP is down sharply, but as the economy reopens there are many success stories. There are restaurants doing well with outdoor dining and delivery, and there are restaurants going out of business. There are homebuilders cashing in on millennial demand and homebuilders starving for both capital and land, unable to take advantage. There are retailers who understand the advantages of the Internet, and those that are still doing business like they did 5 years ago. In today’s fast-tracked world, 5 years is a millennium.
There is a clear separation on Wall Street between winners and losers. Perhaps the winners are becoming a bit overvalued. There may be bargains among the losers. But businesswise, I don’t expect the retailers who haven’t adapted to ever be winners again. Do you want to hear a list of retailers who have died? Montgomery Ward, Ace Department Stores, Kresge, Kmart, JC Penney, Woolworth, Sears etc. Those are just some of the biggies. Adapting is tough.
The same is even true in technology. Giants of 10 or 20 years ago have faded or are fading. Cisco#, Oracle#, IBM# and Intel# are all losing share. They will survive and participate in growing market opportunities, but they are all struggling to keep up. That doesn’t mean they are destined to failure. But it does mean that if they want to compete, they have to obliterate layers of bureaucracy formed as they were maturing. It can be done. Perhaps the best example is Microsoft#. When Satya Nadella replaced Steve Ballmer as CEO, change became apparent almost immediately. The company quickly transformed itself from a PC-centric, Windows-based enterprise to one foundationally built on networking and the cloud. Nadella correctly looked forward to where the world was headed and not backward to where its foundation was built. Over 40 years ago, I wrote a report on corporate incest talking of companies where management came up through the ranks. In many cases, magnetic leaders, those who were brilliant and had the vision to see the world ahead, were followed by successors who tried to soldier on down the path thus created. In the case of Apple#, for instance, that has worked brilliantly as Tim Cook, who took over after Steve Jobs died, was the perfect CEO to carry on the master plan. But even at Apple the question will arise when it is time to replace Tim Cook, who is going to rise with a new vision? One can take smartphones only so far. Mr. Cook has properly morphed into services using the iPhone as the center of a platform to build upon. In a pending 5G world, Apple will still have opportunity.
But look at Cisco, Oracle, IBM and Intel, where successor management lacked the charisma and brilliance of its predecessor. Maybe the best example is Intel. Intel created the microprocessor. It became the brains to the personal computer. Led by a trio of larger than life leaders, Intel was a huge success. But since the last of the three, Andy Grove, left, Intel hasn’t changed its path. It continues to develop successor generations of microprocessors but its pace has slowed, allowing companies like Nvidia and Advanced Micro Devices to sail past. Its manufacturing leadership is also gone. Intel may have to use sub-contractors in the future because companies like Taiwan Semiconductor can make chips using smaller line widths than Intel. The lead has gotten so wide that Intel is ready to concede that it can’t catch up. Nor has Intel been successful branching out from microprocessors. Others are trying. IBM has a new CEO and made a nice acquisition last year in Red Hat. Hopefully Red Hat can add energy to IBM, and not have that same energy sapped by IBM’s bureaucracy. Larry Ellison, Oracle’s founder, still hovers over the company with the title of Chief Technical Officer. But he is in his 70’s today and isn’t the brash young kid of 40 years ago (although still pretty brash!). Here again, an acquisition (NetSuite) is starting to reinvigorate the company. But while Oracle can win against some old-line companies like IBM and SAP, it loses to newcomers like Salesforce.
Energy isn’t limited to technology. Best Buy succeeded by pushing BOPAC, a new-age acronym that stands for Buy Online, Pickup At the Curb. Not only did that prove to be a successful tactic in our Covid-19 world, it is likely to remain part of the company’s arsenal when Covid-19 fades away. It also means that future stores can be smaller and still drive the same sales. Best Buy had obvious advantages over Nordstrom during the pandemic as PCs and related products became home office essentials. Fancy shoes did not. But Urban Outfitters didn’t have such obvious advantages. Same store sales fell 13% as many stores were closed in Q2, but it had a much larger online presence than any of the department stores. That difference mattered. It wasn’t something Urban developed after Covid-19 arrived, it was there before. That is what is so critical. Companies that look ahead thrive. Companies that try to catch up usually don’t. That is why each generation brings new leaders. Some of the old do catch up, many don’t.
This week the Dow Jones adjusted its Industrial Index, adding ServiceNow, Amgen, and Honeywell, while removing Raytheon, Pfizer and Exxon Mobil. Exxon had been in the index since 1928. Dow Jones wanted greater technology emphasis. With Apple splitting its stock 4-for-1 next week, a new addition was needed. Amgen is one of the first successful biotech companies. It replaces an old-tech drug company, Pfizer. For Honeywell, it’s a rare return to the Dow Jones Average. Honeywell entered the Dow when it acquired Allied Chemical. Raytheon inherited the spot from United Technologies after the latter split into three parts. The other two, Otis and Carrier, clearly didn’t make the grade of being a Dow component. Raytheon on its own didn’t belong either. Honeywell is one of the most tech savvy industrials. Hopefully it will have a longer stay this time around. As for the departure of Exxon, it is simply a realization that fossil fuel stocks are fading in importance. Chevron is the only remaining energy company. The key to note is that each change was driven by technology. The newer member is more technology centric than the company it replaced. Technology is at the root of everything. Restaurant menus are QSR coded and available on your smartphone. No more dirty paper menus to handle. Some upscale restaurants use iPads that even welcome you by name. When an entrée runs out it can be removed from the menu immediately. The waiter no longer has to disappoint you. Hotel check-in no longer requires a front desk attendant. Self-service checkout is quickly replacing standing in line. The list goes on.
All this sounds great, but we still live in a Covid-19 world. Tomorrow at 9am Fed Chair Jerome Powell will speak to a virtual Jackson Hole conclave. He will likely lay out a roadmap that suggests that interest rates will remain low for a very long time, at least until inflation is persistently above 2%. While there are pockets of inflation and shortages as the economy restarts (e.g. housing prices), America is operating at 70% capacity, with gobs of money sloshing around and an unemployment rate hovering around 10%. Those aren’t the ingredients for inflation. Interest rates near zero for longer means P/E ratios will remain elevated. As earnings recover with P/Es remaining high, the near-term path for the stock market appears higher. Over time investors will have to pay the piper. When rates ultimately normalize, P/Es will normalize as well. But that is beyond the horizon for now. The path of least resistance still points higher.
As for Covid-19, the pace of new infections is slowing. That probably won’t continue once the weather cools, schools restart all over the country, and we return indoors. But an upswing isn’t a spike. Without a spike the economic recovery will continue. Shortly, newer faster tests and monoclonal antibody-based therapeutics will arrive that will be helpful. The path to a better 2021 is becoming clearer. That is why the stock market continues to climb. Still, stocks of companies in the industries most impacted by the virus continue to lag. They do show occasional strength, but the path back is slow. For the market to continue to march forward, eventually the banks, industrials, and energy names have to participate.
Today Chris Pine and Macaulay Culkin both turn 40. “Home Alone” was released almost 30 years ago. Melissa McCarthy is 50.
James M. Meyer, CFA 610-260-2220