Morgan Stanley
  • Research
  • Jun 24, 2020

COVID-19 Boosts E-Commerce, Resizing U.S. Retail

Why social distancing may have kicked online shopping into higher gear—with potentially lasting impact on brick-and-mortar retail margins.

The coronavirus pandemic set in motion many behavioral changes that are likely to stick, even after social-distancing requirements relax and businesses reopen. In just a few months, virtual fitness classes, video conferences and grocery delivery became ubiquitous—along with a new age of online retail shopping.

One of the most profound shifts for retail has been in softlines—apparel, footwear, linens and other segments—that prior to the pandemic, still thrived in brick-and-mortar stores. While e-commerce sales for these categories had already been ticking higher in recent years, lockdowns may have accelerated digital penetration for this segment by two years—and investors would be wise to note the shift.

“Months of lockdown forced more consumers online. For the foreseeable future, will they now think twice before shopping in crowded stores, particularly if they can easily acquire those same goods online?" asks Kimberly Greenberger, who covers North American specialty apparel and department store retailers.

For 2020, Greenberger and her colleagues expect e-commerce to account for 32% of all softline retail sales—a 9% annualized increase. While she expects the share of online sales to drop slightly to 30% in 2021, a surge in digital adoption likely will have a material impact on retail brick-and-mortar margins that some investors don't seem to fully appreciate.

The upshot: E-commerce giants could stand to gain an even greater share of consumer wallets, at the expense of department stores and specialty retailers that rely heavily on in-store traffic. Among wholesale apparel and footwear brands with strong direct-to-consumer businesses, however, the outlook is upbeat, but nuanced.

Sheltering In and Shopping Online

Consumers aren’t spending as freely as they did before the pandemic. Among many households, a pattern has emerged. After initially stocking up on necessities, such as cleaning supplies and toilet paper, they began shopping online for discretionary items, such as clothing, household goods and outdoor equipment—purchases they rationalized because they weren’t spending on travel or dining.

“This year is setting up to be an e-commerce inflection, as the combination of sheltering-in-place, lower spending on experiences, and government stimulus have all driven more dollars online,” says Brian Nowak, equity analyst covering the U.S. Internet industry. His team estimates that e-commerce grew 58% year-over-year in April, four times faster than in 2019 and in the first quarter of 2020.

All told, e-commerce could grow 25% annually in 2020, even if consumer spending weakens in the second half. “We believe that changes in consumer behavior mean more spending dollars are up for grabs," says Nowak. “Consequently, we're raising our U.S. e-commerce estimate by roughly 10% over what was previously modeled for both 2020 and 2021."

Morgan Stanley Research has raised their U.S. E-commerce estimates by roughly 10% for both 2020 and 2021

Source: Company data, Morgan Stanley Research

A Blow to Brick-and-Mortar

E-commerce has disrupted many segments of retail, but change has been more gradual for softline goods. Consumers often prefer to try on clothing, shoes and accessories before they buy, and spontaneous purchases play no small role in incremental sales.

Still, the past few months have changed consumer habits, perhaps permanently. While shoppers will eventually venture back to department stores and malls, they may do so less frequently and more selectively. Given the high overhead of building out and operating physical stores, even small declines can erode margins for earnings before interest and taxes (EBIT), even for retailers that also sell online.

“When digital sales cannibalize store sales, it results in less efficient retail margins, as stores wrestle with fixed costs," says Greenberger. Her team estimates that, since 2010, specialty and department store retailers have lost about 28 basis points, or hundredths of a percentage point, of EBIT margin per each percentage point shift to e-commerce. “In other words, with a six-point estimated higher digital penetration to 30% in 2021, from 24% in 2019, retailers stand to lose about 170 basis points of EBIT margin post-COVID."

A Boon for Some Brands

Not all retailers will suffer the same fate. Notably, Morgan Stanley's recent analysis excludes clothing retailers that buy excess inventory from brands and department stores. These business models, which are built around in-store “treasure hunts," are hard to recreate online.

Broadly speaking, though, brands with strong wholesale business models could come out ahead. In recent years, many leading brands have taken steps to drive more sales to their own websites. In doing so, they've gotten to know their customers better, improved their inventory management and boosted their gross margins.

For these companies, greater e-commerce adoption is a boon. “E-commerce sales tend to have high average order values and lower fulfillment costs, which average 10% to 19% of digital revenue vs. 20% to 25% on store sales," Greenberger says.

In the case of one of the world's largest athletic brands, a greater emphasis on direct-to-consumer business is key to its long-term outlook. “We estimate that its online segment operating margins are more than 8% higher than both store and wholesale segment margins," says Greenberger, whose analysis of this particular brand suggests that every additional point of digital sales penetration translates to 10 basis points of EBIT margin growth.

EBIT margin has declined 430 basis points for Specialty Retailers and 410 basis points for Department Stores in the past 10 years
(Sales Weighted Subsector EBIT margin)

Source: Company data, Morgan Stanley Research

This isn't to say that e-commerce is a slam dunk for all wholesale brands. Winning over consumers requires creating exceptional digital experiences, particularly for softline goods where fit and feel make all the difference. Shoppers may think twice about heading back to crowded stores, but they still care about store design, product mix and customer support.

Take, for example, one leading company that straddles retail and wholesale, with trendy apparel and home furnishings that are highly curated. Although its flagship brand is a staple near college campuses, the company has been successfully moving more sales to digital. In 2019, 44% of its sales were online, and that number is on track to reach 61% by 2024. “Their narrow store base, high digital mix and superior fashion execution are reasons to be upbeat," says Greenberger.

For more Morgan Stanley Research on the outlook for retail ask your Morgan Stanley representative or Financial Advisor for the full reports, “Long-Term Advantaged, Disadvantaged Retailers Post COVID-19" (Jun 1, 2020) and “How Fast Will E-commerce Grow From Here?" (May 31, 2020). Plus, more Ideas from Morgan Stanley's thought leaders.