Focus on the retail
Our monthly newsletters have occasionally focused on particular sectors experiencing notable change. We’ve reviewed the energy sector as new domestic supplies of oil and natural gas reset the expectations of the global marketplace. We’ve discussed the recovery of the housing sector following the housing-centered crisis of 2008. We’ve considered implications to financials given the change in direction of interest rates.
To earn notice, these changes have generally been distinct. However, there has been a slowly creeping trend that has finally gotten the attention of the media: the gutting of the retail environment. Traditional retail sectors – particularly the cyclical consumer discretionary sector and, to a lesser degree, the more stable consumer staples sector – are undergoing a reset of their own.
In the next few newsletters, we will consider the current retail environment, draw some inferences on how this change will affect the economy, and think about how investors might respond. This article, the first in a two part series, we’re going to consider what changed in the retail environment and how we got here.
Let’s review the commonly accepted causes for the weakness in the retail sector. To begin with, retailers experienced a typical boom-and-bust cycle. Overinvestment in retail spaces in the 1980s and 1990s were often financed with debt. The retail outlet expansion began cannibalizing sales from other locations in an effort to dominate market share at the expense of profitability-per-store. Recognizing this mistake, there have been no newly built shopping malls in the past decade, but the surplus of underutilized retail space lingers on. Even before the accelerating slowdown over the past year, there was an excess of retail square footage available given store traffic and in-store sales trends.
Overexpansion might have been a manageable problem, except for the new paradigm of the digital economy. Starting in the late 1990’s, stores that sold information and media in a physical format (newspapers, bookstores, movies, music, & video games) began to feel the pressure from digital retailers. The trend towards digital really accelerated in the smartphone era as personal computing devices became ubiquitous. MP3 players and online music stores fundamentally replaced primary distribution for the music industry. There is ultimately little difference between reading a book on a tablet than on a printed page. Watching a movie streaming from Netflix or downloading a videogame is more convenient than traveling to Blockbuster to purchase the identical product. The replacement and augmentation of traditional media to the digital environment has been ongoing. So, instead of Media Play and For Your Entertainment stores, we can buy products through Apple and Google storefronts.
As digital retail and ecommerce become more sophisticated, online purchasing began to take sales from traditional brick-and-mortar physical stores. Amazon, for instance, started as an online bookstore outlet and is now selling everything from apparel, appliances, automotive, to sporting goods and more. EBay has products, new and used, of nearly any type and any era you can envision.
Physical stores with finite space cannot compete with online retailers with the variety of in-stock brands. Individual brands can do business directly with consumers online thus bypassing the necessity of working with retailers and the embedded complications of a physical store (e.g. competing for prime visible shelf space). Moreover, online shopping can maximize price efficiency because physical stores have embedded overhead - inventory costs, renting retail space, staff salaries, and so on.
Casualties of retail
These pressures on the retail environment have caused a number of retail stores to declare bankruptcy and shut down. Skeptics may assert the fact that stores shut down all the time; it’s part of the creative destruction inherent in capitalism. Is the retail environment so unusually troubled? In a word, yes. So far, Credit Suisse reports the store closing rate is more than double the number in the prior year – about 2800 stores in the first quarter. We are on pace to meet or exceed the 2008 financial crisis rate, which had a record 6200 store closings. In short, times are bad for retailers. Here are some highlights for 2017:
- Top national department stores have announced shutting down hundreds of locations this year. JC Penny announced in was closing 138 stores in March. Sears is shutting down 150 stores, both Sears and Kmart locations. MC Sports and Macys shut down 68 stores apiece.
- Broad reaching superstores and supermarkets like Marsh and Wal-Mart are facing trouble. Wal-Mart has been trimming staff and store locations since last year, while the razor thin margins, food deflation, and high competition are impacting profitability.
- Specialist chains are collapsing across a spectrum of industries. The problems are not limited to narrow industries, but a widespread malaise in retail. Fashion and apparel stores, the lynchpin of consumer discretionary stocks, are suffering. Clothing and accessories stores like Wet Sea and The Limited, Abercrombie and Fitch, Rue 21, Crocs, and Bon-Ton chains are closing operations, declaring bankruptcy, or shutting down locations. Electronics retailers, which cater to different demographics, are equally suffering; HH Gregg filed for bankruptcy and is shutting down all 220 stores, joined by hundreds of stores closings from previous bankruptcy pariah RadioShack and GameStop. Office supplier Staples announced closing 70 additional stores in May.
- The slowdown equally applies to high-end brand names, like Bebe clothing or Guess, as it does to discount brands. Payless Shoes is considering bankruptcy with 500 stores on the chopping block. Discounter Dollar Express is closing stores, bought out by Dollar General.
- Store closings aren’t simply a symptom of agile competitors acquiring less profitable peers. For instance, outdoor goods Gander Mountain announced bankruptcy and shut 32 stores down. This hasn’t cleared the way for its peer Eastern Mountain Goods, which also announced bankruptcy and is shutting down dozens of stores nationally.
So far, we’ve reviewed the broadly accepted argument for the changes in the retail environment and provided enumeration of store closings. Without context, this information can seem academic. For a more visceral exploration of what a failing, or failed, retail environment looks like, there are documented video walkthroughs – literal explorations - of closed retail spaces. Exemplifying our cultural shift to digital media, we encourage you to go online and seek out any of a number of urban explorers (e.g. try looking up “Dan Bell” on YouTube, who specializes in partially or completely abandoned “dead malls”) to explore the crumbling and obsolete past of retail America.
Our next steps into the future of retail
Readers may be discouraged by this article. Investors might look at the stock prices for Target stores and Macy’s, each down roughly 30% in the trailing 12 months, and think there are only reasons to be pessimistic. The problem with that thinking is that the positive earnings forecasts haven’t been universally applied; earnings growth is being concentrated in a fewer key winners and losers, but there are companies which are thriving. Remember, despite all the doom and gloom, broad equity markets are up. More pertinently for investors, consumer spending estimates, the lifeblood of retail, are optimistic for the rest of 2017. After weak earnings results in Q1 2017, bargain hunting investors have been betting on a broad earnings recovery. Moreover, the Consumer Discretionary sector as a whole had a stellar month in April, and it was the top performer.
In our next article, we’ll take a look at how retailers are adapting to the paradigm shift and how we, as investors, might navigate the tenuous future of retail.
Sources and other reading