Retail Wreckage: Is the Department Store Industry on the Brink?

The past week was brutal for the department store industry. Quarterly earnings from a number of brick-and-mortar retailers, including Macy’s (NYSE: M), Kohl’s (NYSE: KSS), J.C. Penney (NYSE: JCP) and Nordstrom (NYSE: JWN), were downright ugly.department store industry
Sales are declining for these retailers, and they have resorted to deep discounting to clear excess inventory, resulting in profits falling off a cliff. There are a number of reasons for their struggles, including an unfavorably warm winter followed by an unseasonably cool spring across many parts of the country.
But perhaps the biggest concern is the threat posed by Internet retail, specifically (NASDAQ: AMZN). Amazon is a far bigger danger to department stores than weather, which is often just a cyclical fluctuation.
Are any retail stocks worth buying?

Retail Wreckage

Macy’s was first up to the earnings plate, and it missed expectations by a mile. Earnings were $0.64 per share, down from $0.80 per share in the same quarter last year. Analysts were expecting $0.76 per share. The company now expects sales to decline 1% this year, versus previous expectations of a 1% increase.
Earnings reports from Kohl’s, J.C. Penney and Nordstrom weren’t much better than Macy’s.
Kohl’s missed analyst expectations on both revenue and earnings. Adjusted earnings came in at $0.31 per share on $3.97 billion of revenue. Analysts expected Kohl’s to earn $0.37 per share on $4.13 billion of sales. Same-store sales fell 3.9% from a year ago and Kohl’s total revenue fell for the first time in six quarters.
Meanwhile, J.C. Penney reported a loss of $0.32 per share last quarter. While its adjusted EPS managed to beat analyst expectations, same-store sales fell 0.4%; analysts were expecting a 3.2% gain. The stock has fallen 25% in just the past month.
Nordstrom’s earnings fell 64% last quarter, to $0.26 per share. Same-store sales declined 1.7%, the first decline in almost seven years. Analysts were expecting $0.47 per share in EPS. Nordstrom saw some success with its popular Nordstrom Rack off-price brand, but this was more than offset by continued weakness at its core Nordstrom banner.
Macy’s, Kohl’s, J.C. Penney and Nordstrom all slashed their full-year outlooks, which means the retail crisis isn’t going to get better any time soon. What all these retailers seem to have in common is the 800-pound gorilla in the room: Amazon.
Amazon offers consumers the convenience of at-home shopping at far lower prices than department stores. Amazon has also sped up the pace of its deliveries and now offers two-day shipping on most of its products.

Tread Carefully

Amazon is simply killing physical retail, and since consumers love using Amazon, its momentum doesn’t seem to be slowing down any time soon.
That’s why the only retail stock I would recommend at this point would be Macy’s. Macy’s stock is cheap, like its peers, at 10 times earnings. However, it has a unique catalyst that could warrant a higher valuation going forward: real estate.
Macy’s has 823 Macy’s and Bloomingdales stores, more than half of which are owned outright by the company. These stores are predominantly located in prized areas – approximately 80% of Macy’s mall stores are in the highest-grossing malls in the country. Institutional investors are starting to notice Macy’s real estate value.
Last July, Starboard Asset Management published a note pegging Macy’s real estate value at $21 billion. Considering Macy’s entire market capitalization is less than $10 billion, there could be significant untapped value here.
Macy’s CEO, Terry Lundgren, has stated the company is considering different options for its real estate. There is a decent chance Macy’s will monetize its real estate, through a REIT or a similar structure, which could unlock value for shareholders.

Key Takeaways

Amazon is changing the way Americans shop, perhaps in an irreversible way. Shopping malls could be rendered obsolete because of the shifting trends, and that would take a good number of department stores with it.
For that reason, investing in retail today is a dangerous game. The key for investors is to find a retailer that either can’t be “Amazoned,” or has an ace up its sleeve in the form of real estate holdings, like Macy’s.
DISCLOSURE: Bob Ciura personally owns shares of Macy’s (NYSE: M).

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