by Clement Thibault
Since the advent of e-commerce, traditional retailers and the malls they anchor have been eclipsed as the premier destination for US consumers. As American lives get busier and more hectic, shopping from the comfort of one's home during non-traditional store hours is rapidly becoming the new normal. As a result, one thing is becoming ever clearer: traditional, brick-and-mortar retailers are struggling to find their place in this new world.
During the coming week, four major retailers are scheduled to report. Walmart (NYSE:WMT) and Macy's (NYSE:M) will begin the week when each reports on Tuesday morning before the market opens. Walmart is expected to report EPS of $1.3 on $130.9 billion of revenue, while Wall Street is expecting $2 in EPS and $8.5 billion in revenue from Macy's.
TJX Companies (NYSE:TJX) companies will report on Wednesday morning before the bell; investors will be looking for $1 in EPS and $9.4 billion in revenue.
On Thursday, after the market closes, Nordstrom (NYSE:JWN) will finish out the retail week. Wall Street is anticipating $1.15 in EPS, on $4.3 billion in revenue.
According to the latest economic release, U.S retail sales beat expectations in January. Department stores sales climbed 1.2 percent, the biggest increase in over a year. Sales at clothing stores were up 1 percent, also surpassing expectations, posting the biggest uptick in almost a year.
After being undercut by Amazon (NASDAQ:AMZN) and similar online competitors for quite a few years, is there any hope for traditional retailers?
Walmart
Just last week, news broke that after having held a position in WMT since 2005 (and adding to that position in 2014), Warren Buffett's Berkshire Hathaway (NYSE:BRKa) sold over 900 million dollars worth of Walmart shares over the course of the last quarter. Considering that Buffett is regarded as one of the savviest investors in recent times, this should make every investor consider what might really be at stake before taking any new Walmart positions.
However, putting the Oracle of Omaha's decision aside, Walmart hasn't done poorly this past year, growing revenue by 0.9%, 0.5% and 0.6% respectively during each of the past three quarters, year-over-year. Its operating margins, however, are at their lowest point ever, after shrinking to 4.33% last quarter. And the effort needed to turn Walmart around will certainly put added pressure on those already shrinking margins.
On the bright side, Walmart's online efforts are increasing and might eventually be effective enough to persuade investors that the retail behemoth is still relevant. After Walmart's $3 billion purchase of Jet.com in August and the acquisition of online footwear retailer Shoebuy.com this past December for $70 million, last week, Walmart also bought Moosejaw, an online and conventional retailer specializing in outdoor apparel for $51 million. Add all of this to WMT's free two day shipping on shopping carts with over $35 of merchandise, and it's obvious that Walmart is making visible efforts to boost its online footprint. As of last quarter online sales grew over 20%.
At $69 a share, Walmart appears to be reasonably priced. Its P/E ratio of 15 reflects the uncertainty regarding its ability to compete with Amazon and other retailers, for the reasons mentioned above. One thing to like about Walmart is its rising Free-Cash-Flow per share alongside its declining Price-to-Free-Cash flows. At $6.79 of FCF per share, or $10 for every dollar in FCF, Walmart is the most attractive it's ever been by those two metrics.
With $484 billion in sales TTM, Walmart has the customer base, the financial clout based on $21 billion in Free-Cash-Flow TTM, and judging from the success of its recent online efforts the proactive management needed to make necessary shifts and adjustments to its business and business model. Coupled with rising retail sales and Walmart's defensive nature as a cheap and affordable source of a myriad of consumer staples, as well as an almost 3% dividend that has been growing for 43 years straight with a 43% payout ratio, we think this stock is worth a second look by income investors, if not everyone else.
Macy's
Our opinion of Macy's hasn't changed during the past quarter. At its current share price of $32 and P/E ratio of 15, it simply isn't a good enough value.
The company's revenues and earnings have been declining for seven quarters. The jumps in share price seen after the August and November earnings calls were driven by smaller than expected declines. Of course, the stock also gave back all of its earnings report gains—and more—rather quickly, since a less-than-expected decline isn't really cause for celebration nor for a higher valuation longer term. Still, though the news is lackluster, the company remains profitable and strong cash flows from operations in the 2nd and 4th quarters are enough to keep the company and the 4.62% dividend alive.
In addition, though there are many things about its outlook that could be considered dismal, Macy's has a huge hedge which provides a safe floor beneath its share price—the growing value of its prime real estate portfolio. Not many companies can compete with Macy's on this metric.
Its midtown Manhattan flagship store sits on 2.2 million square feet of prime property; overall Macy's owns 141 million square feet of retail space in 46 states including within major cities such as Los Angeles, San Francisco, Chicago, Dallas and Houston. Though the retailer announced at the start of 2017 that it would close 63 stores and cut 10,000 jobs, Macy's real estate holdings do two things for the company and its share price: the holdings ensure a minimum value for the enterprise, making it worthwhile to keep an eye on Macy's P/B ratio, currently at 2.6 and buy with very little risk should it get closer to 1, and it makes the company attractive for potential acquirers.
The acquisition idea wasn't pulled out of thin air either. Canadian holding company Hudson's Bay Company (TO:HBC), which owns Lord & Taylor, Saks Fifth Avenue, and others, reportedly has attempted a takeover approach for Macy's struggling business in early February. Hudson's Bay has done similar deals before in Europe, buying distressed retailers and financing the acquisition by spinning off some of the acquired real estate.
Activist hedge fund Starboard, which owns about 1% of Macy's, believes the department store chain's real estate to be worth over $21 billion dollars. If this assessment is true, spinning off the retail business, or selling, it might make more sense for the company given its current struggles and the changing landscape of the retail industry.
Though we wouldn’t recommend buying a stock based only on takeover rumors, considering Macy's' real estate portfolio and its still-profitable stores, a P/E of 10 or a P/B of less than 2 would make us feel more comfortable about the risk/reward ratio.
TJX Companies
TJX Companies, owns such off-price and deep discount department stores as T.J. Maxx, Marshalls and HomeGoods among others, and has numerous retail chains worldwide. If Amazon is eating Walmart's lunch, T.J Maxx is the thorn in Macy's side.
TJX pulled in over $32 billion in revenue during the past 12 months, $6 billion more than what Macy's brought in. While Macy's and other retailers are seeing flat to negative revenue growth, TJX continues to demonstrate exemplary expansion in a world of struggling retailers. It's been growing steadily at an average annual pace of 6.8% for the past decade or so. Indeed, it seems the company's business model is attractive enough to continue bringing in heavy customer traffic. Same store sales increased 5% across the board last quarter, while Macy's' decreased 3.3%.
The only drag on TJX right now is its International operations (ex- Canada). TJX operates stores globally including in the UK, Australia and Germany. The company has about 2800 stores in the US, 400 in Canada, 550 in Europe, and 35 in Australia. It enjoys some of the industry's best operating margins at 11.8% for the last quarter. However, its European expansion isn't doing nearly as well; margins on the Continent for the recent quarter jumped to 7.9%, after being held below 5% for the first two quarters of 2016.
Similarly, its same store sales, while outstanding in the US, were flat for its International segment. Needless to say, a strong dollar didn’t help matters, completely offsetting 13% revenue growth driven by new international stores in Europe and Australia. For now the, it looks like the international business will continue to weigh on the company, at least until it optimizes.
The company's share price, currently $77.19, has been stagnant for the past year, trading between a narrow $75 to $80 range, reflecting market sentiment towards the retail sector. TJX's relatively high valuation—P/E ratio of 23, P/B ratio of 12—reflects the current state of the business and the industry.
However, TJX remains a growing company. Its international segment is still a work in progress. It should start pulling its weight once local store networks are optimized for synergies and efficiency which will improve operating margins. The company's business model has proved to be steady and effective, and we believe TJX is one of the finest companies in the retail sector at the moment. It's a well run company with an already demonstrated track record that still has more growth ahead of it. We see it as one of the most attractive retail sector stocks right now.
Nordstrom
By far the most upscale retailer in our group, Nordstrom sells higher-end clothing and accessories via 123 full-price stores and 215 discount, Nordstrom Rack stores in the US and Canada. From a sales perspective, the company is in a good shape; it posted $3.4 billion in revenue last quarter, up by a bit over 6% compared to last year. Over the past three quarters it grew 3%, which, given recent conditions for the retail sector in general, is an acceptable number.
The retailer has been on the news lately for dropping Ivanka Trump's apparel line, after noting that sales of the brand have reached a point where it wasn't financially viable to keep them in stores. The decision prompted a Presidential tweet denouncing Nordstrom for its 'unfair treatment' of his daughter. News coverage, whether for good or bad reasons, is often positive for brands. The impact on Ivanka's brand was immediate: sales of her perfume rocketed to the top of Amazon's best-selling list. The impact on Nordstrom, between boycotters and supporters, still remains to be seen.
A breakdown of revenue sources does show some weakness. Revenue from comparable full-price stores is down 6.3% year-to-date. Like many others traditional retailers, Nordstrom continues to suffer from declines in its brick-and-morter stores. Fortunately, the slack is being picked up by Nordstrom's online offering, which grew over 10% during the same period.
Still, the growth rate of Nordstrom online dropped from 17% last year to just 10% this year, over the first nine months of the year.
The company's off-price chain, Nordstrom Rack, is an attempt to limit the flow of customers leaving JWN's higher-end stores for competitors such as T.J. Maxx and Marshalls, and is growing at an impressive 11% rate, almost entirely offsetting the drop-off in full-price store traffic. However, this growth has been spurred entirely by 26 new, mostly off-price store openings during the first 9 months of 2016. Comparable sales for existing Nordstrom Rack stores since the beginning of 2016 are up only 0.4%, after having been down 0.2% in the same period last year.
Because it's a higher-end retailer, Nordstrom is less of a defensive stock, and more of a consumer cyclical. Should a downturn in the economy occur, companies like Walmart or T.J Maxx will fare better than Nordstrom. This may seem irrelevant in light of rising consumer sentiment and US retail sales, but it's still worth noting, especially for long-term investors.
Nordstrom's price per share has already dropped dramatically over the past few months, from $61 in early December to its current $46. However, with a P/E ratio of 25, Nordstrom's growth problems are not discounted enough. Shares sell for a price befitting a stable retail chain with small growth prospects—which is, in fact exactly what Norstrom is—but a deeper drill-down into the components of its growth reveals a troubling pattern of slow comparable sales and slowing growth in online sales. We would not recommend initiating a position at this time, especially if the stock rises on better than expected results (as has happened with Macy's after its last two quarterly reports).