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Tuesday, November 23, 2021

Holiday Season - Good Time to Think About 2022 and Beyond

Source: Observations from the Executive Suite
By Jeff Kramer, Managing Director, NRC Realty & Capital Advisors

While 2021 has brought about some incredible changes, some of which are unprecedented in history, top of mind for most of us remains the Covid-19 worldwide pandemic, the first in 100 years. Maybe this winter will bring some of its last moments, even though its impact will never be forgotten. Overall, hopefully, most of us have a lot to be thankful for this Holiday Season.

As interesting economically is the incredible response of the U.S. leading the world by fighting off a potential deflation through record monetary and fiscal stimulus such that 10 Year Treasury rates in the U.S. are currently negative by over 3%, maybe an all time record. Because the economies of the world do not have the growth potential to use the money created immediately, it has helped generate a huge increase in asset values particularly reflected in stock prices and multiples, home values, and selected commercial real estate prices.

U.S. corporations have seen a terrific increase in demand despite product shortages, which has allowed them to raise prices faster than costs have risen, at least so far. Overall operating profit margins (i.e., before interest, depreciation, and overhead) of the Standard and Poor's 500 Index companies are running approximately 13% of revenue this year compared to a 30 year average of 8%. Retail sales are currently projected to be at least 10% higher in 4Q 2021 than prior year - for some companies already higher than pre pandemic levels. Not an easy pace to sustain with our declining demographic position, low immigration rates, declining labor participation rates, and much less fiscal and monetary stimulus in 2022. Recent economic statistics are showing solid improvements in U.S. industrial production and maybe capital spending, as interest rates stay low for now, an important assumption because our National debt keeps ballooning and taxes are proving difficult to raise. Hopefully, that key 10 Year Treasury benchmark will remain well below 2%, an important level that I think would start to reverse the huge asset inflation we have seen. With so many crosscurrents, it remains too soon to determine whether inflation will persist or if deflationary trends will return. Governments have to have some ammunition to fight off declining economic activity at some future point, very hard to do if short term interest rates start at zero.

So, what about 2022 for our industry, convenience store/petroleum/foodservice, on the retail side, plus mainly petroleum on the wholesale side? Being deemed an 'Essential Industry' during the COVID shutdown was huge, as many new consumers were introduced to our stores, and one outcome was that average ring per customer improved significantly and more than offset reduced customer counts. It should seem clear that the push towards EV electric vehicles is irreversible, driven by climate change concerns. It is International in scope, as each manufacturing company and country does not want to be left behind, as what happened with China and solar panel power generation. China has been a long time driver of imported rising oil demand, and they are investing heavily in EV production. Even though some EV companies will fail, it will bring a sizable capital expansion, as seen in recent announcements by Ford and GM as examples. Technology is moving quickly, which could dramatically drop the prices and ongoing maintenance costs for EV's, especially as volume increases as Henry Ford discovered.

In our industry, EV's will bring fewer cars to the forecourt, which would also impact store sales, since most charging will be done at night at home when electric demand and rates are lower, or at work or supermarkets for convenience. Petroleum prices could stay strong, as petroleum has many advantages like cheap transportation and typically faster reaction times for infrastructure interruptions. Petroleum prices will have to stay high long enough to encourage drilling, at least for several years more. Perhaps rapid electric charging technology will improve sufficiently at some point to where recharge times and costs get greatly reduced and can be readily available at convenience stores?

A key question for me for 2022 and beyond is whether pricing power in each industry is sustainable. Wal Mart recently announced it is choosing to not pass along full cost increases to maintain margin percentages, obviously going back to their roots. Their stock price declined despite marked improvements in internet sales and expectations of a strong Holiday Season. They must feel their improvements in long term demand and market share will allow them to earn more profit long term. Interesting that Target, Costco, Amazon, and others made no such announcements and their stocks kept increasing. Given the incredible records being broken this year of 'coming out' stimulus, it would certainly be logical to expect some margin softening. This would include convenience store items as well as fuel. Perhaps not as much with foodservice, as many in our industry still have large advantages with quick and often tasty fast food, plus many complimentary product choices and interesting services, such as beverages, chips, and desserts, and now gaming, CBD, car washes,etc., all part of convenience retailing and not always available on line at lower prices. And retail and wholesale competition will always be very regional and local, often with sizable differences.

It seems to me that, on balance, SCALE will be important than ever to compete in the modern world. The reason some tech companies have stock prices that have risen exponentially is because they can achieve scale, plus the operating leverage and pricing power that goes with it. Keeping up with technology can be expensive, not just for capital outlays, but to be sure you have the best people making these proposals to Management. Not an easy job. Even then, larger companies have better buying power leverage for in store products typically by a few percentage points, and currently much better for fuel, based on branding, RIN's, logistics, etc. From the marketing side, top of the mind recall is incredibly important for the broad array of products we offer, and even more so now with home delivery becoming more efficient through robotics, automated vehicle delivery, etc. Yet smaller companies can move faster, and if they can see how they fit with the competition, may always be able to keep a step ahead and not just rely on unpredictable margins to save them.

In summary, it is critical to have a good plan going forward, not just for facilities and competitive scale, but the right people that understand the company's long term goals and achieving them at affordable costs.

Travel well and stay well.


Managing Director
(303) 619-0611