Sean O’Reilly: Vincent Shen and I are going
shopping on this consumer goods edition of Industry Focus. Greetings Fools, I am Sean O’Reilly joining you here from Fool Headquarters in Alexandria,
Virginia. It is Tuesday, November 10, 2015 and joining me as we basically walk through
a virtual shopping mall is Vincent Shen. What’s up, brother?
Vincent Shen: How are you Sean? O’Reilly: Not too bad. When’s the last
time you went to the mall? Shen: I never go to the mall.
O’Reilly: Yeah, me neither. My wife rides the train depending on … anyway. So Vince
I’m anxious to get — because I talked to Dylan on Friday about this – we here at
the Motley Fool were looking to participate in the annual Foolpalooza Conference.
Shen: Sure. O’Reilly: What was your favorite part?
Shen: I think getting to meet a lot of the other Fools that I don’t usually work with
was awesome. But in terms of activities I have to say I hadn’t played paintball in
like 5 years. O’Reilly: Oh boy.
Shen: So getting to lay some paint down and taking some hits …
O’Reilly: Did you go Rambo on everyone? Shen: It was intense. Everybody here is very
competitive. I appreciated that. O’Reilly: Good. Good, good, good. Do you
have any wounds, bruises? Shen: Yes.
O’Reilly: Yes? Does it hurt to walk? Shen: No that’s fine. I was a little sore
afterwards I’ll tell you that. Just because a lot of crouching and running around, but
overall it was a great time. O’Reilly: Cool. Very good. Well diving into
our show which is, we’re basically going to walk through a virtual mall as I said,
and just talk about the major department stores. It’s been a rough year to be a department
store, no? Shen: Yeah absolutely. So overall for apparel
retailers in particular, they’ve really taken a beating this year. I think that has
to do with some shorter term trends, but also some high-level developments for the industry
and the competitive landscape that we’ll get to later in the show. But just to give
you an idea for example: Macy’s — down 30% year-to-date.
O’Reilly: Which you wouldn’t have expected, but anyway.
Shen: Oh no, you’re fine. So Macy’s down 30% year-to-date, Kohl’s down 28% year-to-date,
Nordstrom’s down 21%. Overall actually JCPenney is doing quite well at plus 32%.
O’Reilly: The surprise winner because they were being left for dead not 1-1/2, 2 years
ago. Shen: I think that’s part of it. The beginnings
of their turnaround are starting to take hold essentially and you have to keep in mind that
… O’Reilly: They’re definitely the outlier.
Shen: They’re down 80-90% from their highs in 2012 before …
O’Reilly: Because they were $30-40 stock, correct?
Shen: $40 stock exactly. So I think that’s a bit of an exception. But all four of these
companies that I mentioned are actually reporting their earnings this week. Which is why I wanted
to talk about, a little bit about just higher level what to expect, and what investors should
really be focusing on when their management teams are on their conference calls talking
about their results for this quarter, and just their guidance for next year.
So for example, stocks are down obviously due to a streak of underperforming quarters
for most of these retailers. Also we’ve had a lot of in the news, big store closing
announcements from JCPenney’s, from Macy’s and some unfavorable shifts in consumer trends
around people who are just buying more media, or buying more electronics.
Also things like fast fashion, and also lastly, it even seems the weather these days is stacked
against these companies with a very warm, warm fall/winter that we’ve been having.
O’Reilly: So take us to the back and just give our listeners some perspective. I’ve
been a Fool for 2 years now and one of the first major stories that Mark Reeth and I
used to cover when we did a consumer goods-based show back in the day, was JCPenney.
This is when they were in some serious trouble. This was late 2013, early 2014, I mean it
was like, “Are they going to survive the holidays?” Actually that Christmas, Christmas
2013 they had to issue a bunch of stock for cash in order to have cash for inventory purchases
and stuff for the holidays. I mean it was getting tight.
Shen: Very dire straights, I’m sure. O’Reilly: And so of course they announced
a bunch of store closures. I mean they were going to close, I think 92 give or take 2
or 3 stores in 2014. But the interesting story of the last few years and the two, bringing
it back around, the two major stories that we’ve seen with department stores is not
only has JCPenney the most troubled department store, been closing stores. But the strongest
player here, arguably Macy’s has been closing stores too. Everybody has been trying these
store concepts. So what’s been going on with these four department stores in light
of these facts? Shen: Sure. So like you mentioned the store
closings of JCPenney’s, especially during that — when they’re still on the downward
rung — essentially it was pretty bad. The past year they announced they were going to
be closing about 40 locations in its weaker location, the weaker stores, pretty much.
O’Reilly: Well and this was the joke, again harkening back to 2 years ago, so good luck
finding that on YouTube. But it was like I remember I lived in Indianapolis for a time
and they were closing a JCPenney store in some farm town in Indiana, 2 hours, and I
was like, “Why was this ever here in the first place?” But anyway.
Shen: Well actually the interesting thing is, some of the steps that they’re taking,
that these stores are taking that we’ll talk about in a few minutes here, kind of
addresses the potential that they see in smaller markets.
So JCPenney closing 40 stores, I’m sure they’re going to end up closing more too
as these leases expire. They’re going to look at which locations are performing well,
not performing well, and obviously I think overall that’s just part of their turnaround.
O’Reilly: Keep the major open ones. Shen: For Macy’s they also announced they’d
be closing about 35 to 40 underperforming locations. And the big thing here is they
actually mentioned that though they’re closing, that represents about 5% of their total store
base, it only represents about 1% of the revenue. O’Reilly: That’s just under 1,000.
Shen: So that gives you an idea how poorly …
O’Reilly: Automatic win. Automatic win. Shen: Exactly. So again I think the stocks
actually traded down a little bit on the Macy’s news, but overall investors should really
keep in mind that this is basically the management team cleaning house here and trying to shore
up their operations into their strongest sources which makes perfect sense to me.
Overall with those store closings that we just discussed, that is also shifting with
some openings too. But the thing is they’re not opening their typical anchor stores in
malls. They’re shifting to a lot, and this is a trend that we’re going to see among
many of the bigger retailers, towards these off price, more discount-based pricing and
smaller footprint stores. So Macy’s announced they’re going to have
their Backstage. It’s Macy’s Backstage. And then we also have Nordstrom Rack, Off
Fifth by Saks Fifth Avenue. O’Reilly: Which has been hugely successful
— Nordstrom Rack. Shen: And also Neiman Marcus Last Call, Kohl’s
is also doing … O’Reilly: Is that a bar?
Shen: So Kohl’s is also doing something similar and the main theme here is smaller
footprint. And what that means is, again, they can avoid the shopping malls a lot of
which are struggling overall unless you’re in the top-tier, targeting the top-tier of
wealthier customers and shoppers. And so that they can basically target urban areas where
you can have, a smaller store can fit basically into the general spaces that are available
in those kinds of areas. They also target smaller markets where okay
we don’t have to open this massive store. We can open something maybe 50% the size and
that can be sustained by a smaller city or town for example that you mentioned like that
small one in Indiana. So this is a big push from them. And in general the retail sector
is seeing a trend for shoppers who are looking for value offerings. So companies like TJX
and Kohl’s. O’Reilly: That have not been struggling.
Shen: They have not been closing locations. They had a few rougher quarters as well …
O’Reilly: Well I was actually referring to a Ross and TJ Maxx. Those stores are killing
it. I mean they’ve had a great 5, 6 years. The other thing that I wanted to add some
color on was the smaller format store within a store concepts that these guys have been
doing. And we can obviously talk about this a little
bit later and everything, but they’re trying to make the best use possible of their giant
stores that remain by having the store within a store. That way you have a reason to go
in there. And the best example of this is JCPenney’s relationship with Sephora.
Their former chairman and CEO actually got his start at, the owner of Sephora, which
is oh shoot what is it? The French company. Shen: I do not recall.
O’Reilly: Anyway, yeah. But the owner of Sephora, they have this relationship with
JCPenney and that’s why there’s Sephora in there. That’s regularly highlighted in
JCPenney’s quarterly conference calls like, “Our Sephora store within a store concept…”
Shen: Well yeah, that’s drawing the customers in through the door and guess what? When they’re
there, they’re going to do other shopping in other departments and it’s been a huge
boon for them. O’Reilly: Evil scheme.
Shen: So going back to the, some of the smaller kind of discount store concepts that these
retailers are launching into, this is something that’s leaked through to a lot of the, I
feel the retail sectors. So for example, Walmart, Target doing the
same thing. They’re trying to open smaller locations in the cities to attract — everybody
wants to attract millennial, younger shoppers who are looking for good value and more discount
merchandise. And again, this also applies to Whole Foods. They have their 365 concept.
O’Reilly: Which I can’t wait to visit. Shen: Which they are experimenting with now
and the whole point of that is that it’s the Whole Foods 365 brand so lower prices
to again, appeal to younger shoppers and people who are in these urban areas where they can’t
potentially launch a full-size Whole Foods in every city.
O’Reilly: Absolutely. Well before we move on I wanted to point our listeners once again
to the newly redesigned Focus.Fool.com. There you’ll discover a special offer to join
the Motley Fool Stock Advisor Newsletter for all industry-focused listeners. Although IF
listeners have access to a special discount on Stock Advisor that works out to $129 for
a full two-year subscription. Just go to Focus.Fool.com to take advantage of this offer. Once again
that is Focus.Fool.com. Alright so diving back into the retail sector.
Vince I’m anxious to get your thoughts on any short-term headwinds that investors need
to be keeping in mind as all these retailers report this week.
Shen: Sure. So as we discussed previously we have incoming third quarter reports from
companies like Macy’s, JCPenney, Nordstrom, Kohl’s.
O’Reilly: So this will have all the back-to-school shopping but it’s really the prelude to
the holiday season. Shen: Exactly. So some things that I thought
were particularly interesting because earlier this week a lot of these retail companies
took a beating in the market. Their shares tumbled 3, 5% or more on some very bearish
Wall Street reports. And these reports generally cited something where I think it’s funny
that it seems like even nature is acting out against, is like stacking the odds against
these companies which is through the very warm weather that we’ve been enjoying recently.
Where all over the country for both October and November so far we’re breaking records
for warm weather. And what’s happening is when the weather is really cold, shoppers
don’t want to go out and the stores suffer. Unfortunately on the opposite end when it’s
really warm, in this case at this time of year people are pushing off their winter clothing
shopping. So what’s happening is that these retailers
are, and they have a lot of excess inventory especially for their cold-weather apparel,
and that’s definitely going to be something that I’m sure is reflected for this quarter.
O’Reilly: You’ve got me curious now. Will their inventory balance on the balance sheets
this week? Will they be up a little? Shen: Exactly. So that’s definitely something
that I feel will get covered by the management teams on their calls and they will cite this
as an issue. Something else also that’s higher level is the U.S. dollar and the strength
of that. Because that’s hurting, that’s basically making it much more expensive for
people to come to the U.S. as tourists. And Macy’s for the previous quarter, they
cited the fact that weaker tourism hurt them in major hubs like New York City and their
flagship store where the results simply weren’t as strong because the goods are more expensive
relative to the tourist local currency… O’Reilly: People just buy it at home.
Shen: And the fact that they’re just not going to do as much spending. But that’s
something that’s going to impact more of the higher end retailers.
O’Reilly: Right. So real quick just before we move on. What’s the key takeaway if you
own any number of these companies? Shen: Well for these two issues I think the
most important thing is to remember that these are short-term headwinds. Of course the currency,
the strong U.S. dollar has been in play for almost 2 years now. And some people believe
that that’s going to be the case for another year or two. But you are looking at this from
the foolish perspective of, “Is this fundamental business a sustainable strong one over 15,
20 years?” These are things to keep in mind and I think
are very interesting as parts of the retail business and what they encounter, but not
major hits on the basically the investment proposition.
O’Reilly: Right, okay. Well that in mind I do want to look towards the future for these
companies and the shifting consumer spending towards more media, more electronics, as opposed
to spending an afternoon shopping at Macy’s. Apparently these companies do have value though.
Shen: Oh of course. So there’s two trends that we’re seeing for these apparel retailers
that I also think, that are much longer term, are something that we’re kind of getting
the beginning hints of that investors will want to keep in mind. And the first is that
there is a shift from spending on a lot of untraditional goods like clothing towards
media, and also electronics. A good example of where we’ve already seen
this start to take hold and the companies are suffering as a result and they’ve had
to basically institute major transitions in their business and their product portfolios,
is the toy industry. So think about like Mattel for example or
Hasbro where they had these major brands like Lego, like Barbie I’m sorry, not Lego — like
Barbie or Hot Wheels or the American girl dolls. Those have all struggled and I see
it every time I visit my little cousin for example.
O’Reilly: Why by those when you can give the kid an iPad?
Shen: Exactly and he’s on his iPad most of the time over playing with the typical
action figures or some games along those lines. So, that’s just something that we’ve seen
in general and I think is going to start leaking into the apparel retailers as well where people
are just going to be focused more on getting the latest iPhone rather than getting a new
pair of boots. O’Reilly: Well not only that but these companies
are, and this it is harking back to what we were talking about earlier with the smaller
format stores and having less inventory and everything. I did want to point out that I
love what Macy’s has done. And I don’t know if you came across this
in your research, but they just built a $300 or $400 million distribution facility in Oklahoma
of all places that pretty much rivals an Amazon warehouse. Macy’s is on it with their inventory
management and their distribution. And just with the way the country’s working with
getting things in 2 or 3 days buying on Amazon, you don’t need a huge store. You don’t.
Shen: And I’m glad you brought that up because that’s another big trend that we’re, a
big shift that we’re seeing for these companies is Macy’s is being really proactive about
adopting this omni-channel strategy where they are meeting customer’s needs in the
store and online. Because there’s no denying that ecommerce is obviously been growing as
a percentage of total retail sales for a long, long time now.
O’Reilly: Well arguably everybody wins because if you go into a Macy’s or any one of these
stores 20 years ago, they literally had to have every size of a pair of jeans available
pretty much if they wanted that sale that day. Now they can have 5 of the sizes the
person likes it, they can just be like, “Okay order online, we’ll be at your place in
two days.” Boom. Shen: Or pick it up at the store.
O’Reilly: Either way. Shen: So they really want to provide shoppers
with those options. Kohl’s hasn’t been as strong as some of the other, some of its
competitors in adopting that omni-channel strategy, but it definitely has it in mind
and management has cited the fact that they’re going to be pursuing that much more aggressively.
And so the last thing is a bit more of like financial engineering in my view. But it has
to do with REITs, Real Estate Investment Trusts. We kind of saw this a little bit in the gaming
industry with Penn National Gaming. O’Reilly: A couple years ago, yeah.
Shen: Where they basically have these casinos, they spun off a REIT which basically owned
that property and the actual casino operator would lease that back. The benefit? The investors
in the REIT get really stable revenues from those lease payments, but they also get more
favorable tax treatment since it’s not taxed at that level.
O’Reilly: At the corporate level. Shen: Exactly.
O’Reilly: So, a number of retailers are all of a sudden doing this. The first bull
case that referred to any of these comments was of course Sears. Hasn’t turned out quite
as well but a lot of analysts have come out and said that they think that the real estate
at some of these other ones, particularly the stronger brands like Macy’s, are worth
even more than the Sears locations. Shen: So Jeffery Smith, he’s an activist
investor with Starboard Value and this is a pretty impressive number. He thinks that
Macy’s real estate, I just think about its flagship store for example in New York.
O’Reilly: That’s worth a billion dollars on its own, right?
Shen: He thinks that the real estate performance for Macy’s is worth $21 billion. The company’s
mark cap right now is just $15 billion. O’Reilly: Now did he say what … okay so
you can throw that number out. Okay all Macy’s stores are worth $21 billion for their real
estate. However you need to have a use for it to get the real estate value. To get the
value out of real estate, one of the bull cases I remember, one or two years ago, was
Sears. They wanted to chop up the stores and to make them into tiny little stores. You’d
have like a Best Buy mobile and all that stuff. Is that what he’s thinking with the Macy’s
stores? Shen: Well the thing is overall the company,
the management team has already started to think about the property they own and the
ways they can diversify its use. I think at another location they kind of took the second
floor and just started renting that out to another tenant.
O’Reilly: Wow, who was it? Shen: I don’t recall. But that was just
something that I had seen quickly. But it’s just part, overall I look at it more so as
the fact that these companies currently in their current form, they own a lot of property
and a lot of real estate obviously. And whether something like a REIT can help unlock that
value is definitely something investors should consider.
O’Reilly: Got it. Wow. Well thank you for your thoughts, Vince.
Shen: Thanks Sean. O’Reilly: Have a good one. If you have any
questions or comments we’d love to hear from you. Just email us at Focus.Fool.com.
Again that is Focus.Fool.com. And as always people on this program may have interest in
the stocks they talk about and the Motley Fool may have formal recommendations for or
against those stocks. So don’t buy or sell anything based solely on what you hear on
this program. For Vincent Shen, I’m Sean O’Reilly. Thanks for listening and Fool