Vito
Hello, and welcome to Strategic Alternatives, the RBC Capital Markets podcast. We're here today to uncover new ways to raise capital, drive growth, and create value in an ever changing world with insights and outlooks from the RBC Capital Markets team. I'm Vito Sperduto, global head of mergers and acquisitions, and as always, I'm joined by Larry Grafstein, Deputy Chairman of Global Investment Banking. Hi, Larry.
Larry
Great to be here, Vito.
Vito
And today, our special guests are from our consumer and retail team. Douglas Trauber is global head of consumer and retail here at RBC, and Hugh Paisley is the co head of US Consumer and Retail Investment Banking here at RBC. Douglas and Hugh joined us almost two years ago, and I know it's been a Very active period over the last two years with their clients and across the space, and so we're looking forward to hearing those perspectives today. Douglas and Hugh, welcome to the podcast.
Douglas
Great to be here. Thanks, Vito.
Hugh
Looking forward to it, Vito.
Vito
So let's start off, and I think, just to kinda level set, we've talked The fair bid in recent podcast about what we saw in one and what how that leads into 24, and so just for our audience, If we think about the overall market, last year was the 1st year where global, and A volumes were below 3,000,000,000,000 Since 2013, so it's been about 10 years, we've had at least 3,000,000,000,000 of value, peaked in 21 at about 5,700,000,000,000, and last year, it was about 2,900,000,000,000. So seems like not a big drop off, but certainly, we all expected greater volume, and we saw a nice pickup in the second half of the year. A lot of the green shoots and deals that we saw in the broader, and a market have been corporate transactions primarily in the, you And the highlights have been some large deals across energy and health care and the like, and in the US market, we've certainly seen that the Corporates had a nice pickup last year, and the private equity firms probably, you know, were off about 17 or 20 percent in terms of volumes from what we saw from a deal perspective. Douglas, why don't we start off and give us some perspective on what you saw in the consumer and retail space in one and and especially how the year ended up and how it's sort of going into 24.
Douglas
Let's start with the consumer because I think taking a little bit of a halo back to where we've been in the last 4 years is important. If you go to 2021 one just the beginning of one, we were in a very unique situation with the consumer. Let's focus on the mid market and lower end consumer. It was a unique period in that we were all at home, and so we had little less spending, and what happened over that two year period was Those consumers drove their savings levels to, you know, recent highs. As we move forward, though, during that period of time, two things happened. One is the easing of the money supply drove demand, and we had significant supply constraints As a consequence of manufacturing closures, both in the US, but in particular in Asia, and also a lack of labor, We drove inflation because of demand versus supply, and we entered into 22 in a different situation, and that situation was unprecedented inflation as well as rising interest rates to try to stop that.
On the inflation side for the consumer, that really choked off that discretionary spending over that period of time. So if you look today, at the end of 23, what we have is a consumer that, on a basis of. Their in their nonmortgage interest expense as a percentage of discretionary income is the highest level we've seen in you know, it it's near its historical highs, and that's a consequence of both the driving the inflation down, but also The rise in interest rates that causes the credit card debt, the auto loans to go higher, and larger banks.
Larry
Doug, are now reporting. That that credit card debt is is reverting to pre COVID levels.
Douglas
Absolutely. So we've got a consumer that stretch, and we've got corporates in mass that are are hovering near started zero same store sales. Within retail, we have discretionary sales that are negative, and we have consumables Consumable sales that are while they were strong, and I'll come back to this later, in terms of the fortification of our of our corporate clients and their balance sheets And their strengths and their EBITDA and what they can do with that the overall picture is one that's normalizing to 23. 3rd party retail, Scale is important. Value offering is important. Convenience to the consumer is important, and in a world of where we are now going forward in GDP growth, we're at the top of the proverbial mountain, and I say that because grocery, for example, grew top line sales between COVID into to 23, one plus percent decelerating, as I mentioned, and it's about flat today.
They grew EBITDA at a higher rate as a consequence of scaling that Sales growth, and and as a consequence of the free cash flow, I was able to pay down debt, pay higher wages, and pay other stakeholders for distribution, and looking forward from this past year and and out towards a a no growth back to GDP Outlook for grocery, for example, we saw, and a activity.
Larry
Yeah. So, I mean, just to take a a step back, Doug, You have this situation where it's almost especially for public companies that, you know, growth was quite robust because of some of the Idiosyncratic factors associated with the pandemic, and now, you have a a combination of rates going up, maybe the consumer getting squeezed a little bit By the higher cost you referenced, and at the same time, pricing power coming down, and so it it really raises an inflection point issues For companies, you know, of all sizes, especially in the public markets. Without a doubt.
Hugh
So let me give you an example, and and that goes to what I call balance of power, and this is going back a little over a year, but the Kroger Albertsons transaction that was announced. The logic for that transaction is if I'm a GDP grower and Kroger spent 15 years investing in price to get closer to Walmart To be more competitive. They've invested in their infrastructure to become more omnichannel and for the experience. Given the competitive dynamics in the marketplace, to further that investment, they need scale. They need to leverage. That scale, they need to be to enhance their ability to drive down a procurement. They need more ubiquity nationally to help drive other services for both logistics within their with their own drive manufacturing, but also their retail media network. So this is an example of creating the scale and creating the and and leveraging the free cash flow from this to drive efficiencies and not duplicatively with their competitors to enhance their competitiveness against and lower that gap to Walmart and to drive growth.
Vito
Douglas, I think those are all great points. I think One of the things as we sit here on January 25th is, obviously, this morning, when GDP figures were announced For the final quarter of 23, we saw that GDP increased at a 3.3 percent annualized rate in which resulted in a two one half percent growth for all of one, and so clearly ahead of what Wall Street was expecting, and when we think about sort of some of the drivers there and and some of what it means for the consumer, we also got some great news that From a consumer perspective, there was some strong spending on their part that helped drive expansion, and I think it was like a 2.8 percent Personal consumption expenditure increase in those numbers.
Vito
So a lot of data, but again, the signs are feeling good, and I think the consumers. It feels like they're they're continuing to spend. We'll see how that goes, especially as rates stay higher, and so, you know, that's gonna increase costs in terms of Any mortgage rates or or debt that they have out there, and does that impact their spending on a go forward basis? But certainly some positive news, especially for a lot of your clients. Hugh, tell us a little bit of what you're seeing with this environment. How are your clients feeling as they're heading into one and and their mindset from a, you know, a consumer perspective, the economy, and the like. What what's impacting them?
Larry
It's a good question, Vito. I think that, you know, Across specialty retail, which is my area of of focus and coverage, it really depends on which subsector you're covering. You know, I think in for instance, in the home furnishing segment where you saw a tremendous pull forward of demand in 21 and 22 From the stay at home and trends related to COVID, you saw some whip whipsaw on gross profit margins with delays in container shipments, Creating promotional demands, and what you've really seen is 23 was, you know, hopefully, a more. Normalization year from the trends that from the whipsaw of the last 3 years, and as you look out to 24, you know, I think the the real question For home, which is tends to be much more discretionary, is what is the strength of the the consumer?
You know, there will be pent up demand. There is Millennial and Gen z housing formation, which is certainly creates tailwinds. But, you know, I think the question is is, you know, where is the strength of the consumer, and you know, as we look back in 23, there was a tale of two halves. The first half where it looked like we were moving towards A recession and a hard landing, and I think that now we're starting to feel a little bit more optimistic, and I think this this builds on Vito what you were just saying in terms of the GDP print is that the consumer seems to be resilient, and I think that the unemployment rates are a good stability factor, and we are gonna see some signs of Return to discretionary spending.
Yeah. We see that in the services sector. I think about areas that were very active in and a, like the fitness market, med spas, where consumers are spending for more experiential. They want to get out of the house. Certainly, we saw that in travel and leisure. Those are the areas where we see A lot of activity and a lot of investment dollars, and you know, I think as we look out over the next 12 to 24 months, We're gonna start to see some of those sectors that haven't been as active get active simply because there's been a number of private companies that Need to find their the the their next transition that might be sponsor owned. There's family owned businesses that are looking for to raise more capital, and there are ecommerce companies that where we've seen, you know, from a an environment where there were low rates and and money was easy To money now being hard and a lot more competition in those sectors, and they need to find larger homes to be a part of.
Larry
I do wanna just. Ask you, Hugh, because the one thing common to all retail clients is the concern about a recession, and as you say, the concern seems to be. It seems to have moderated compared to maybe a few months ago. But as a retailer who's very sensitive to these cycles, How are some of your clients managing that uncertainty right now, and and how does thinking about deals fit into that? That's a great question, Larry. I mean and again, it comes back to which sector are you in. There's certainly a cautious approach. There's a greater focus on expenses And managing through that. But there is also an underlying tone of needing to prepare for the future. You know, I think one of the big things In terms of consumer trends that we're seeing is this demographic and channel shift, and it was pronounced during the ecommerce.
It's something that we've tracked for a long time Of how ecommerce has grown, how omnichannel has grown, and really as we think about, you know, what the future of retail is, it's adaptive retail, and that's where you're using the tools of technology like AI to really analyze and what the consumer And each individual consumer wants and demands and and be able to use predictive technologies to Streamline not just what the customer sees on the ecommerce site, but also understand what the consumer is doing in the retail store And bringing that back to what the supply chain is, and so, you know, I think that all of that comes down to investment dollars, and so depending on who you are and what investments you've made, you've gotta look at, how do I grow my revenue?
How am I how do I continue to be relevant to my consumer? How do I manage costs, and are there capabilities out there that I can build organically, or do I need to seek external Ways of capturing one that, whether that be through and a or strategic partnerships.
Vito
Hugh and Douglas, I know you both just got back From spending 3 full days down in Orlando at the annual ICR conference, which I believe is the 26th annual conference that they've held down there, and you know, with the number of public companies and private companies that attend, and especially the time of the year just after the holiday period, it's probably a great indicator in terms of how everybody's feeling and what the sentiment of your clients are going into the year. What was the tone down there, and and were there any big themes that you that everybody was talking about as they're looking forward to 24.
Douglas
I think the sentiment, both by private equity and corporates, was one of more optimism. Coming into January, Particularly coming off the lows that we saw with the peak of interest rates in October, November, and where the and when the markets were And where sales were trending towards the end of the year coming into January, we saw a more slower rates, a more activity or or or approach towards accessing the market, and that on the sponsor side, given they were pretty much sidelined for 22 and 23 other than specific situations, and that went to cost of capital, bid ask spreads, and also what areas they were going to focus on. The theme for sponsors, I think, is More active.
Douglas
They've got a lot of capital put to work. Services focused retail, where they can be more differentiated and grow and leverage versus scaled retail, and I say that from the perspective of of the sectors I cover that really require Increasing scale, increasing investment in what or commoditized goods. So on the corporate side, I similarly think that a better consumer, lower rates, Labor growth, while nominal growth historic over the last 15 months was trailing while growing, it was trailing inflation. We had an inflection to positive real inflation growth. So I think from that perspective also, we we're seeing the the customer and the optimism From both our corporates and from sponsors towards more activity to grow.
Larry
The big difference between January 23 and January one. In January 23, we're looking, you know, at still a steep heightening curve in interest rates and and what the Fed's going to do and how do we think about Exiting our portfolio companies. This year, you know, we're seeing a plateauing of where we think interest rates might get to and Ultimately, that we see potential of an easing cycle, as we move into the end of the year, and what does that mean in terms of Monetizing some of the portfolios that they have, whether that be through sale processes or IPOs.
Vito
Let's Shift a little bit, guys. So as we think about sort of what might portend from a deal environment going forward, you know, when we talk to our clients and we're talking to CEOs, we're talking to boards. You know, we're getting a lot of insight of how they think about things. We're trying to make sure that there's a level of confidence at the CEO level to understand the business, have a good view on what's gonna happen on a go forward basis, and as we all know from the many years that we've all spent in this industry, That's when our clients can make decisions on transactions. So as you think about the discussions you're having today, real time with our clients, Where are they focused?
Like, how are they thinking about you know, we've talked a lot about different economic, macroeconomic inflation concerns. Are geopolitical issues coming into play? Are the elections later this year coming into play? You know, how are they thinking about it, and or are they just looking at potential strategic opportunities as they're coming up and Feeling like this might be an environment where they pull the trigger.
Hugh
Let me take the corporate side, and and I'm gonna do it on mass convenience grocery, and there's two pieces of this. You've got scaled players in these sectors that have competitive differentiation, from the ability to procure, from the ubiquity and their ability to invest in technology and in particular AI. For example, I I spent time with the CFO at one major company, and I was amazed not at just the size of their AI team, But the progression of where they are, and and Hugh commented on this, in terms of driving efficiencies and inventory management and pricing algorithms and personalization, and as you think about go forward, I bifurcate larger scale and smaller scale companies within grocery, within see stores, Within a number of these sectors, III believe in retail Darwinism where we have to grow and we have to both, As I said before, create value for the consumer.
Douglas
How do I do that? Create better experience, and this is omnichannel focus on our Across the sector, and how do I invest and do that and create a much better experience for the consumer? So if you look at the 3 largest corporates, Walmart, Amazon, and Costco. Each of them have a subscription model, and that subscription model is either the membership at Costco, the Amazon Prime or Walmart Plus. Within that model, they're adding more value. They're creating AAA more neutralization, if you will, of the Cost of delivery or pickup for merchandise. So I reference that because as I you move to the other corporates, How are they going to effectively compete long term, and I think as we sit here and I bring back the whether you're in grocery at zero growth right now on the top line, and you've got labor and cost growth.
Whether your convenience, while you're strong in CPG volume or CPG pricing, This is driving cash flow, but you see, we don't know how far out a declining maturity curve on fuel, potentially. How am I going to keep up with the scale players? So the answer going forward is those that are not those 3, if you're large enough, is there a capability I can acquire? Is there a ubiquity or a geographic expansion that I can acquire? How can I try to compete with those top 3 in a way that Better measures, and I think that's going to be a theme going forward, and if you think about and a, m and a can be cost driven. It can be revenue driven.
It can be, you know, just capabilities driven. The one thing we haven't seen is convergence driven in retail. We've seen it in other markets. We saw it in Canada with Shoppers in Loblaw and John Coutu and Sobeys to try to try to drive improved efficiencies, better ubiquity with the customer, better loyalty with the customer. We tried to do it here with one deal that was announced several years ago with Albertsons and Rite Aid, and I do think if you look forward, There is the potential that whether that be offline, online, whether that be multi format, there needs to be a thought process within corporates that I think They are thinking this. How can I better compete, particularly in an environment where I've got that kind of competition at the top, and it may be 24. It may be 25, but I think we're going to see more corporate activity that tries to align themselves better to compete against What is a very competitive retail environment?
Vito
Hugh, maybe on the same topic and building on what Douglas just talked about. As we think about our clients acquiring capabilities. Technology is always one of them that we think about, and you know, Douglas, you mentioned those top 3 retailers. I mean, there's a popular phrase that's used now in in terms of the tracking the largest companies, the magnificent 7. I believe that Amazon is the only one in that 7 because all of them are technology related in some fashion. So, Hugh, as you think about acquiring capabilities, whether it's technology, artificial intelligence capabilities, which I don't know if we can go a podcast without using that word. How are your clients innovating? Are they thinking about it more from an organic perspective In terms of developing it themselves, or is time and life too short? Are they going out there and looking to acquire those capabilities? It's a great question.
Larry
I think that the one additional one that I'd throw in is partnership, and I think that, you know, that's an important piece. I think that, you know, I guess, first, or organically, there's certain elements that all retailers have to be able to do. They need to have transactional ecommerce site Where they're capturing data and analyzing data. I think what we what we've seen is that the world has moved on. III mentioned kind of the different The different phases of retail, and we're now at adaptive retail, which which is digitalization on steroids just in terms of how much information you can capture on your on your customer and use to really merchandise and personalize the experience, and so, you know, bringing it back to to to to and a Is it really depends on where you are within that journey?
There are category leaders that have been continuously investing very, very small moves, whether it's In capability driven acquisitions, we saw it with Walmart and Jet. We've seen Home Depot over the last 10 years investing heavily in digital capabilities and engineers to grow their online presence, and you know, I think that they've been able to do things To move into further into ecommerce, further into AI, further into pet personalization, further into digital Media and advertising and other revenue streams, growing their marketplace and growing their relevancy. You know, in those cases, Those companies are are thinking, I already have some capabilities that I've brought in in house. How do I embellish those, and and really, flex those muscles, and in some cases, they're partnerships.
Doug Mcmillan just presented at CES, and he and he did it, inviting the Microsoft, you know, as part of the, you know, as part of the presentation and highlighting all of the partnerships that Walmart has done with Microsoft. Well and and I guess many of these are responding to Amazon and Amazon's increasing breadth and marketplace power and diversification themselves in into such areas as media. Absolutely. There's another level of retailers that are frankly just depending on which sector they are. They're growing, but are they really cons are they really taking market share? Are they taking market share as quickly, or are they just growing merely because of a function of what their categories are doing, and I think those really will feel the pressure, you know, over the next 5 years, over the next 10 years to make those investments that they may have deferred or delayed because the gap is widening between the number ones and the number twos, and so we can see that in a lot of sectors. You see it in the valuations within specialty retail and across specialty retail that there's a real dichotomy between the number one and number two.
Vito
So that's been a good summary in terms of what we're seeing broadly in terms of the larger themes across the space. It's great to hear the positives as we enter 24, especially in terms of the growth we experienced at the end of one as we just heard today from the GDP figures and the continued uptick in consumer spending. There are certainly some headwinds, but I think our clients are feeling stronger about their businesses and especially some confidence with regards to what they're seeing in a forward outlook, and so maybe the growth is not gonna be as large as Some would expect, but they certainly feel better about what it's going to be, and and I think that will portend well for transactions.
Vito
So. Larry, Douglas, Hugh, great conversation. Look forward to continue our dialogue. Great speaking with you. Thank you, Vito. Thank you, You've been listening to Strategic Alternatives, the RBC Capital Markets podcast. Join us for more analysis about what's moving the and a markets in our next episode. If you'd like more information on the topics discussed today, please contact us directly or visit rbccm.com backslash Strategic Alternatives. This podcast was recorded on January 25, 2024. If you're enjoying Strategic Alternatives, don't miss an episode. Subscribe to us on Apple, Spotify, or wherever you listen to your podcasts, and please drop us a review or a comment. Thank you.
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