/Why I Won't Go Near Brick-and-Mortar Apparel Stocks Right Now

Why I Won't Go Near Brick-and-Mortar Apparel Stocks Right Now

Last week, investors experienced a violent sell-off  for many department-store apparel retailers after some companies posted earnings. Macy’s (NYSE: M) , Kohl’s , Nordstrom (NYSE: JWN) , J.C. Penney (NYSE: JCP) , Sears , and Ascena Retail Group all took a beating, down between 10% and 30% in just one week .

The catalysts were earnings reports from several names, although not every company mentioned reported. Still, almost any retailer primarily selling full-priced apparel was sold off, as investors concluded that these companies are all in secular decline. And while many value vultures may be looking at these names right now, I’d stay away for several reasons.

Cartoon bear throws coins angrily and growls.

Image source: Getty Images.

Looks can be deceiving

A secular decline is dangerous, because it makes the stocks in question look cheap, with low price-to-earnings and price-to-book ratios, along with high dividend yields. But there is no telling how quick or severe the pain will be, as evidenced by continued same-store sales declines across the board.

For instance, activist investor Starboard Value LP took a position in Macy’s back in July of 2015, at around $ 65 per share. Its thesis was that Macy’s owned real estate that by itself was worth more than its market capitalization . Starboard proposed selling off Macy’s properties and leasing them back. Greenlight Capital, another prominent hedge fund run by David Einhorn, also took a position in 2016 at around $ 45 a share.

The problem with this theory was that a) if Macy’s stayed in these locations it would have to pay rents, and b) even if Macy’s vacated, the locations were retail spaces that would have to be filled by someone else. Judging by the performance across the sector, it would difficult to find a dependable tenant when everyone was closing stores.

In March, Starboard exited its position, eating a 60% loss. Greenlight exited in January for a smaller, yet still unpleasant, 30% loss.

This is what happens when value investors mistake a turnaround for a secular decline: embarrassing losses. You might think that with Macy’s trading at around $ 23.60 and the yield over 6%, the bottom is in. But as Clint Eastwood said in Dirty Harry : “Do you feel lucky?”

Even good management can’t do anything

In 1988 Warren Buffett quipped: “With few exceptions, when a manager with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact.”

Returning to Macy’s — my punching bag for this article, although my argument could apply to all the other names as well — new CEO Jeff Gennette seems to have an intelligent, well-thought-out, and appropriate strategy. The company reduced head count, is closing unprofitable stores, and is experimenting with new formats in women’s shoes and jewelry. Macy’s also opened up its own discounted format, Macy’s Backstage, which will feature off-price merchandise, and it is expanding e-commerce.

This seems prudent: People are buying fewer full-priced clothes, so the move to footwear and jewelry is wise. When they do buy clothes, they increasingly look for deals. This has given rise to off-price retailers such as TJX Companies ‘ T.J. Maxx, Ross Stores , and Burlington Stores .

The problem is that all of these moves are easily replicated. What’s to stop Kohl’s or Nordstrom from also stocking more footwear and watches? Every retailer out there is developing more robust e-commerce initiatives (usually carrying lower margins), and as customers order more online, companies will suffer sales deleverage from fixed rent and labor costs.

Also, Macy’s is late to the off-price game, a few years behind Nordstrom, which unveiled Nordstrom Rack years ago. Off-price stores can also possibly diminish the larger, more profitable division, so there is cannibalization risk. Finally, if everyone is discounting, why wouldn’t customers go to the stores known for the biggest discounts: Wal-Mart or Amazon ?

The big problem

Keep in mind: The terrible results are happening in an economy that is nearing full employment and where consumer spending is actually good — U.S. retail sales actually grew 0.1% in March and 0.4% in April. Imagine what would happen in a recession.

It’s perhaps fitting that Amazon CEO Jeff Bezos summed up the problem well: “All businesses need to be young forever. If your customer base ages with you, you’re Woolworth’s.” Department stores have been late to adjust to a population that increasingly seeks discounts, and a millennial generation that craves “experiences” and the convenience of shopping online.

Bottom line: Some of these retailers will survive, but it’s hard to pick any winners, and even the survivors are likely to be much smaller companies than they are today. Why play with fire?

10 stocks we like better than Macy’s
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor , has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now… and Macy’s wasn’t one of them! That’s right — they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of May 1, 2017

Billy Duberstein owns shares of, and The Motley Fool owns shares of and recommends, Amazon. The Motley Fool recommends Nordstrom. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Let’s block ads! (Why?)

Latest Articles in Stocks