Happy 2018. The New Year should be a decent one for mergers and acquisitions and initial public offerings in the technology space, but not so great for U.S. equity stocks in the retail, apparel and beauty sectors.
Bart van Ark, chief economist, global for The Conference Board, expects global gross domestic product growth to be in the 3 percent range for the year, although GDP for the U.S. — a mature market — will likely be closer to 2.6 percent in 2018.
While not robust, those percentages could be enough to keep growth at a slow and steady rate for the year, as well as maintain the level of M&A activity seen in 2017.
Maria Watts, who leads the retail investment banking group at Robert W. Baird & Co., said 2018 will be a good year for M&A activity. “If our activity is any indication, we expect it to be a continuation of 2017….This is the biggest pipeline that we’ve ever had going into the New Year,” the banker said, speaking generally about the overall M&A market.
Watts explained that many buyers are submitting multiple bids, hoping to get to the first stage before year-end so they can do management meetings in January and then close in the second quarter. Watts expects the beauty sector to continue to be active in the M&A space, and sees potential for more accessories deals.
“Things are coming to market faster. Private equity firms are holding things for shorter time periods. If the business is doing well, that is helping to boost multiples now. The thinking is that selling now is better so they don’t risk experiencing lower multiples in a couple of years,” the banker explained.
Watts also noted that companies on the acquisition trail are looking not only from a brand standpoint, but are also checking the target company’s capability from a supply chain point-of-view or some other differentiated experience that they can bring in-house quickly.
“People are acquiring capabilities that make it possible for them to compete. It is no longer good enough to have great brands,” she said.
While M&A in general could be on a roll, that’s not likely in the apparel sector. Michael Smith, managing director at D.A. Davidson, said, “We do not anticipate a robust M&A market for the apparel business in 2018.” The banker explained that while he anticipates seeing in his firm’s practice a “number of apparel deals coming to market,” there is lingering uncertainty in terms of distribution channel and where and how the firms grow their sales.
Smith said that even as many of the brands pivot away from department stores to other channels, such as direct-to-consumer on their own web site or to a T.J. Maxx or Costco, “we continue to see apparel slightly out of favor relative to other consumer categories.” Those other categories include beauty, which he expects will continue to do well in 2018.
Smith also said he isn’t expecting a hot apparel IPO for 2018, noting that firms attracting investors’ attention are those that combine consumerism with technology and experience.
That scenario dovetails with the conclusion of IPO tracking firm Renaissance Capital. It expects that this year will see an increase in tech IPOs, based on the expected pipeline. Expected to go public this year are Lyft, Spotify, Pinterest and Dropbox.
The tracking firm said there are 61 IPOs publicly on file looking to raise a combine $20 billion, and there could be more as some have likely taken advantage of confidential review. The latter is a process that the Securities and Exchange Commission last year opened to larger filers. One firm hoping to go public next year is Hudson, the operator of airport concessions and duty-free shops, which is aiming to raise $400 million.
As for the equity markets in general, Jeffrey Saut, chief investment strategist for Raymond James, said U.S. stocks are in the midst of a “secular bull market,” and that there’s “at least another eight years left” in the current run. He pegged the current bull market as beginning in October 2008, and noted that secular bull markets can last on average for 14 or 15 years.
The strategist doesn’t see any hints of a recession, and said the secular bull market run is in the middle stages that could have three or four more years to go before it transitions into the late and last of a three-stage cycle.
Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America Merrill Lynch Global Research, is forecasting an S&P target of 2,800, which she said would be reached by year-end. That would represent a 7 percent increase from the December 2017 range. Her team is also projecting 6 percent growth in earnings per share for the S&P 500, outside of corporate tax-related benefits.
Subramanian isn’t so keen on her outlook for consumer discretionary stocks, such as retailers, apparel and beauty brands. She explained that the problem with these stocks during a period of Federal Reserve tightening of liquidity through interest rate hikes is that it tends to result in the companies feeling pressure from wage increases and margin squeezes.
Michelle Meyer, head of U.S. economics, also at Bank of America Merrill Lynch Global Research, said she is expecting the Federal Reserve to raise rates three times in 2018, with another two rate hikes in 2019.
Walter Loeb, former retail analyst and now consultant, said that while retailers ended 2017 with stronger businesses, buoyed by cleaner inventory levels, he expects the promotional environment to continue. “The retailer has to have a hook to pull customers into the store, and that hook is price,” he explained.
On the credit side, Moody’s Investors Service has a “stable” outlook for the retail and apparel sectors. It expects operating income growth to be led by e-tailers and dollar stores. Department stores and discounters are expected to continue to drag down the broader sector performance, along with apparel and footwear and drug stores. The ratings agency also predicted that the number of mall stores would decline by more than 2.5 percent, with off mall growth in openings also decelerating.
For apparel firms, Moody’s said weak traffic trends and high promotional activity will continue to be the top challenges, although companies that have product innovation, cost savings and synergy initiatives could see profit growth this year.