Investors in department stores finally got to unwrap some presents from Christmas. Several of the big chains last week reported surprisingly strong results for the fourth quarter, and their stocks popped.
The late-arriving holiday cheer shows that as a sector, department stores aren't dead. Still, investors need to pick carefully through the bargain bin.
The stores are benefiting from a consumer-driven economic recovery in the U.S., which led to a particularly strong holiday season. In past years, inventory has piled up during the holidays, forcing fire sales even before Santa showed up.
This year, however, the companies resisted the markdowns and still moved merchandise. Kohl's (KSS) reported 6.3% growth in same-store sales—or sales at stores open at least a year—its best quarterly result since 2010. Macy's (M) had its first positive same-store sales result in 12 quarters.
The recent pickup follows a long slump for most of the chains, which have lost customers to online retailers and fast-fashion chains like H&M Hennes & Mauritz's (HNNMY). Retailers announced more than 6,000 store closings in the U.S. last year, and mall traffic has been in a steady decline.
Many of the department-store stocks have fallen by 30% or more over the last three years, leaving them trading at price-to-earnings valuations that trail the broader market. They appear tantalizingly cheap.
Buyer beware, industry experts say.
A real rebound in the sector, says Brian Tunick, an analyst at RBC Capital Markets, "will take at least a few more quarters of positive same-store sales and stable store traffic results."
Indeed, most department stores trade at total market values that lag their annual sales, a sign that Wall Street sees little growth ahead.
To investors encouraged by the recent news, it's worth being choosy now. Nordstrom (JWN) and TJX (TJX) appear to have the most staying power, with Nordstrom the more attractive choice in terms of valuation.
Kohl's and Macy's are showing new life, but both need to prove they can repeat their stellar fourth-quarter performances before the stocks become attractive. And J.C. Penney (JCP) and Dillard's (DDS) remain tricky—volatile small-cap stocks in a declining industry.
Still, economic forces are giving department stores a lift. Consumer sentiment has improved, and the recent tax cuts have put money into the pockets of most Americans. Corporate tax cuts will increase the bottom line for department stores, which had paid particularly high effective rates.
At TJX, which owns the T.J. Maxx and Marshalls discount chains, the new tax law could lift next year's earnings per share by 18%, allowing the company to raise its dividend by 25%, ramp up stock buybacks, and give workers bonuses and other benefits.
Economic growth and tax cuts won't solve the larger issues plaguing the sector.
The chains have responded by launching elaborate turnaround plans, often with grandiose names. Macy's has its North Star Strategy, and Kohl's executives follow "the key pillars of the Greatness Agenda."
In short, they're looking for ways to generate excitement—exclusive products, stores within stores—and to cut costs, often by closing underperforming locations or sub-leasing extra space. Online sales matter too, of course. But brick-and-mortar stores remain an important part of the mix.
Although internet sales get all the headlines, e-commerce remains just 9.1% of total retail sales in the U.S. Even after excluding auto dealers, gas stations, food and beverage stores, and restaurants, e-commerce will account for about 18% of retail sales by the end of this year, according to IHS Markit.
TJX, the discount chain, has been the most successful of the bunch, even though e-commerce is "a relatively small part" of the business, its chief financial officer, Scott Goldenberg, said on the company's conference call on Wednesday.
TJX has benefited from some of the same trends as dollar stores in recent years, attracting consumers looking for bargains. After a rocky start to 2017, a 4% same-store sales jump in the fourth quarter should give investors "a sigh of relief," argues Tunick, who thinks the shares can rise to $91 from a recent $83 and change.
Nordstrom, a premium chain that owns the discount brand Nordstrom Rack, has succeeded with a different strategy. E-commerce accounted for 32% of its sales in the fourth quarter, among the best if not the best of the department stores. (Not all break out online sales.) Nordstrom Rack struggled earlier this year, leading the stock to fall, but it rebounded over the holidays. And its full-price mall stores are relatively safe, with 95% in so-called A malls that are filled with top-quality tenants.
The Nordstrom family, the company's largest shareholder, has also reportedly been looking to buy the entire company with help from a private-equity firm. Nordstrom didn't address the buyout rumors on its earnings call and did not respond to a request for comment from Barron's. Cowen analyst Oliver Chen thinks there's a better than 50% chance the company goes private, and sees shares rising to $60 from a recent $53.
Macy's presents a conundrum. A storied brand with iconic stores, its sales have mostly been falling over the past three years. Bullish investors have argued that the company's real estate is worth more than its enterprise value of $14 billion.
Activist investor Starboard Value pushed Macy's to spin it off from the operating company, but the company has been reluctant to do so. Last year, it sold $411 million in real estate assets.
The recent sales improvement has brought Macy's stock back to its level of a year ago. But without sustained growth, the stock could return to the doldrums.
At Kohl's, same-store sales jumped 6.3% on the back of high demand for athletic apparel and sneakers. Kohl's has experimented with several strategies to drive more traffic, even setting up Amazon return centers in some of its stores. But the company's sneaker bonanza could reverse, as it has for stores like Foot Locker (FL). Kohl's guidance for zero to 2% growth in 2018 looks "too aggressive," argues Morgan Stanley analyst Kimberly Greenberger.
Department stores may have returned to growth for now, but most still don't belong in investors' portfolios.
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