VanEck Retail ETF: Key Discussion Points (NASDAQ:RTH)

The challenge of the retail business is the human condition – Howard Schultz

The VanEck Retail ETF (NASDAQ:RTH) is an investment product that focuses on 25 of the world’s prominent retail stocks, businesses that are involved in retail sub-segments such as distribution, warehousing, food service, multi-line retailing, direct mail and TV retailing, specialty retailing etc. Interestingly, prima facie, even though this is supposed to be a product designed to spread its net across the globe, at the end of the day it is very much a US focused product as 95% of its holdings are based here.

The retail landscape

The last reading of the US retail sales numbers suggested that things remain okay for now, but I’d urge you not to take things for granted. For the uninitiated, March’s reading had come in 0.5% higher, even as the previous month’s reading was upgraded to 0.8%, instead of the 0.3% figure reported previously. However, the key driver here was a surge in gasoline prices as sales at service stations grew by 8.9%.

Over the long-term, I don’t believe it is healthy for the retail environment for sales to be largely gasoline driven, as this will eat into the average consumer’s wallet and compress the spending that would otherwise have gone towards other retail goods, goods that are primarily sold by the constituents of RTH.

The US CPI number which came out yesterday showed that inflation now is at 8.3% (steeper than market estimates of 8.1%), and even if you take out the volatile food and energy prices components, inflation – as represented by the core CPI – still continues to be rather elevated at 6.2%. When the core inflation is at these levels, you can’t wear blinkers and expect retail sales to coast along without any stumbling blocks further down the line.

I say this, more so as the inflation malaise is continuing to make its presence felt, even in what is perceived to be quite a tight labor market. Prima facie, US employees may think that the pay environment across the board looks rather resilient particularly as we’ve just seen the employment cost index grow at its highest pace since 2001, but the more pertinent question is how does this look when inflation is brought into the equation.

Well, as highlighted in the image below, when adjusted for inflation, the employment cost index has actually been plummeting since 2020 and is now close to levels seen since 1975!

The chart below also shows that inflation-adjusted wages for employees across all major sectors (with the exception of leisure and hospitality) have actually declined since the start of last year!

In addition to a weak scenario of real earnings, consider that the Feds Fund rate is poised to surge significantly through the year, even as the bank continues to shrink its balance sheet by $100 billion a month. Under tighter monetary conditions such as this, it would be unrealistic to expect retail spending momentum to be particularly resilient. In fact, those who subscribe to The Lead-Lag Report would note that I’ve been highlighting the growing prospect of a deflationary environment.

Then when it comes to these retailers per se, they are facing their own set of challenges. As noted in The Lead-Lag Report, last year, the nation’s top-10 retailers delivered healthy bottom line growth but you have to also consider the impact of Chinese lockdowns which have upended the global supply chain once again and will only likely put further pressure on the cost base.

Port activity in China has slowed significantly and this has led to the weakest export numbers since June 2020. Look even before these recent supply chain challenges, do consider that US retailers have still not been able to bring inventories back to historical levels.

The chart below shows that the inventory/sales ratio levels still remains at rather lowly levels. When inventories are generally low, retailers are not in the best position to engage in things like discounting which could perhaps abet sales. We already know that with inflation the way it is they will also find it a challenge to pass on these costs to the end consumers; in effect they will probably have to absorb these costs themselves.

What is currently also not ideal for RTH is its inordinate exposure towards the Amazon stock (AMZN) which alone account for 18% of the total portfolio. This is a stock that appears to have fallen out of favor with a lot of investors and you can’t blame them when management recently came out with weak Q1 numbers and also mentioned that they would likely continue to lose money in the next quarter as well. The company appears to have overestimated the pandemic-induced e-commerce momentum which was never quite going to last and they are now paying the price for being too overzealous.

Besides, as flagged in The Lead-Lag Report, the cloud of antitrust concerns in Europe too is weighing on the prospect of the Amazon share.

Conclusion

As noted in this week’s leaders-laggers section of my report, a ratio measuring discretionary stocks relative to the S&P500 continues to plummet and is not far from hitting lows last seen during the pandemic era. We may well witness some buying at those levels, but do consider that this ETF is hardly cheap and currently still trades at a pricey forward P/E multiple of over 20x; the S&P500 on the other hand, is available at a lower multiple of 17.7x.