Like most investors, I am an avid reader of diverse content ranging from finance and history to neuroscience and psychology. Leigh Gallagher's recent book The End of the Suburbs is a must read with some very important implications for people who invest in US equities. I shall spare you from a review, and I will admit, I do not see the suburban situation as dire as Gallagher does. Still, there are several pertinent issues worth discussing, even the issues Gallagher may have gotten wrong.
Millennials Hate the Suburbs
"An oft-referenced 2011 survey by real estate firm Robert Charles Lesser & Co. found that 77 percent of millennials said the plan to live in an 'urban core.'"
One of Gallagher's finer points in the book is her assertion that millennials hate the suburbs. Logically, this argument makes a lot of sense. Many millennials were raised in the suburbs and dealt with the typical grind of suburban life - endless driving, a lack of locally accessible entertainment, and considerable social isolation. After a childhood (and often years of post college graduate life) in the suburbs, millennials have craved change. Several companies like Gogo, Google (NASDAQ:GOOG), and Mike's Hard Lemonade have moved to city centers, hoping to locate close to young talent.
This change has several effects. For one, companies located in suburbs may have trouble attracting young talent. Assuming all other things constant, if a firm is located closer to a place you find desirable, I think you would work at the place with the superior lifestyle profile. This is a net-positive for the company located in the city at the expense of the company located in the suburbs. If this trend remains pronounced, we could see resurgence in demand for downtown office real estate and see the corporate campuses of the 80's and 90's virtually abandoned.
Let's also recall that these millennials are going to become consumption monsters, especially as they move deeper into their careers and make more money. Millennials are waiting longer to have kids, so they will have plenty of money to spend on retail and housing. Companies like J.C. Penney (NYSE:JCP), Dick's Sporting Goods (NYSE:DKS), and Kohl's (NYSE:KSS)-all highly dependent on suburb shoppers-could see sales suffer greatly. The market has already largely reflected this trend, as there hasn't been a mall built in the United States since 2006. Additionally, chain restaurants like those owned by Darden (NYSE:DRI) and Texas Roadhouse (NASDAQ:TXRH) will lose out on business to companies with urban locations. Retailers and restaurants highly dependent on suburban traffic should be very worried.
People are driving Less
The latest data finally shows a trailing twelve month period for miles driven that exceeds the previous trailing twelve month period. Miles driven have been mostly in a downtrend for the past 5 years, reflecting higher gas prices and higher unemployment. One of the main points that Gallagher makes is that people are sick of driving. And who can blame them. "Suburbs" have become so loosely defined over the years that I've heard people living in southern Wisconsin associate themselves with living in the Chicago suburbs. While not only is that not true, it is ridiculous to think that people can spend upwards of 3 hours commuting in single day. That's an extra 15 hours a week which translates to more than a full day lost to commuting every 2 weeks.
In response to this ridiculous commute times, several companies have allowed employees to virtually commute. If everyone living in the suburbs (and exurbs) can virtually commute, then the demand for autos should not fall much. However, the aforementioned trend of millennials preferring higher density living should at least cancel out the impact of virtual commuting.
Plus, not every company is ok with virtual commuting. Yahoo (NASDAQ:YHOO) CEO Marissa Meyer ended the firm's virtual commuting policy because virtual commuters were slackers. This obviously isn't true for everyone, but I think if employers see a significant reduction in productivity, then virtual commuting will go the way of the Blackberry.
Ultimately, this will have a negative impact on vehicle sales. Such is why I believe there will be a lower "new normal" when it comes to North American Light Auto Sales. In the long run, this will negatively impact Ford (NYSE:F), General Motors (NYSE:GM), Toyota (NYSE:TM), and Honda (NYSE:HMC) - or, virtually every major global auto producer. However, I expect the impact to be felt over the next few decades rather within the next five years. As a result, I'm still quite bullish on both Ford and GM.
Will this Materially Impact Oil?
With Americans driving less, you might expect the price of oil to decline. But, I don't see that happening. Passenger miles traveled are hovering around 3 billion total. On the other hand, semi-trucks travel for more than 140 billion miles per year. Commercial trucking has only grown as consumers opt to purchase goods online as opposed to in brick and mortar stores, so even a steep decline in residential light vehicle miles driven won't materially impact demand. We also must not forget our friends in China, who continue to gobble up new vehicles and plenty of oil.
Of course, new fuel optimization technology and greener energy may innovation may eventually come to the forefront. But for the time being, I feel confident betting on oil, and so does Warren Buffett after his recent investment in Exxon Mobil (NYSE:XOM). Continental Resources (NYSE:CLR) is my favorite idea in the energy space.
Those who are Most Vulnerable: Wal-Mart and Target?
When I think of suburbia, I think of the incredibly growth experienced by Target (NYSE:TGT) and Wal-Mart (NYSE:WMT) that ran parallel with suburban growth. Cities favor fragmentation whereas suburbs easily favor retail centralization. Let me explain.
We've all been to Wal-Marts and Targets, and they are literally the size of city blocks. I've been to some of these "Super Wal-Marts" that essentially encompasses an entire small town. Consumers in the suburbs love these retailers because they can get everything in one stop-just like you can on many city blocks.
Target and Wal-Mart have opened some city specific locations to mixed reviews. Due to the low gross margin profile of the respective businesses and the more expensive urban real estate, I'm not sure either will be able to maintain adequate store level profitability.
I would add that a certain portion of shoppers won't shop at Wal-Mart or Target due to ethical conflict, but I think this section of shoppers is so small that it hardly impacts sales. Plus, consumers are so familiar with the low prices at these respective stores that backlash will probably be just temporary in nature.
Still, it begs the question: are Wal-Mart and Target vulnerable over the long-term? Under Gallagher's scenario, neither is particularly vulnerable. She envisions suburbs becoming poorer, which likely increases the reliance on discounters. Further, struggling big box competitors could make real estate even cheaper, thus boosting operating margins. I think sales will hold-up over the long-haul, but profitability isn't likely to get any better than it is now.
Gallagher herself admits the end of the suburbs is a bit dramatic, and I agree. Younger generations may love urban areas now, but preferences could revert back to suburban over time. Schools will also have to catch-up in cities to their suburban counterparts.
On top of the chance that millennials revert back to the suburbs, there are still plenty of people in the suburbs and moving to less dense cities like Atlanta and Phoenix. It may be a foregone conclusion amongst San Franciscans, Chicagoans, and New Yorkers, but there are hundreds of millions of people that enjoy the sprawl lifestyle. Nevertheless, a re-urbanization trend could transform American life over the next century in the same way that it transformed life over the latter half of the 20th century. Investors should pay close attention to demographic trends, as they can provide incredible tailwinds to companies across various sectors.
Disclosure: I am long CLR, F, . I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.