Back when I was a kid in the 80’s and 90’s, the mall was the place to go on the weekends. I wasted tons of money at the mall, on stuff that no longer matters.
Sometimes I’d ride my bike to the mall on Saturday, and pick-up a new cassette tape. Or, maybe I’d buy new tennis shoes. If I didn’t have any money, the mall was just a place to “people watch” and kill time. It was the place to go to see or “be seen” for teens in the 80’s and 90’s.
Now, nearly 3 decades later, the retail landscape is changing dramatically. Malls all across America are dead or dying at an unprecedented pace. Is this the “death of retail” as we know it?
Or, is the proverbial baby being thrown out with the bathwater? Could there actually be good places to invest in retail? Or, should it be avoided like the plague?
The Death of Retail
You don’t have to look far to find the media predicting the death of retail stores. It’s easy to understand why — Every single major U.S. department store has had trouble lately. It’s not just Sears either — Macy’s, JC Penney, even Nordstroms is sucking it up. They’ve all reported terrible store sales numbers the last few quarters.
Most department stores have announced significant store closures in recent months. Large numbers of specialty retailers have been closing too… many of whom have filed for bankruptcy.
Just look at the list of retail closure announcements so far this year:
And this isn’t even in a recession! We’re in the “good times” right now — most people are employed and the economy is growing (albeit slowly). Could you imagine what this retail pain would look like if a recession was to hit?
Meanwhile, online retail outlets like Amazon continue to show solid sales growth in 2017.
A Self-Fulfilling Prophecy
Quite simply, retail stores are entirely dependant on foot traffic. When large ‘anchor’ department stores close, at some point the death of a mall becomes a self-fulfilling prophecy.
A department store typically takes up the largest amount of space in a mall, and it’s considered the “anchor” tenant that draws foot traffic. Typically there is one in every mall.
The anchor department store also has the largest rent bill to pay, and is typically heavily indebted. In the past these retail stores were able to handle the debt load because of high sales levels (malls were very popular places to shop). Now, consumer behavior is shifting online, leaving brick and mortar retailers in a very bad position.
Since the crash of 2008, consumers have begun shunning department stores for online retailers like Amazon or Jet — primarily because online retail offers convenience, better prices and wider selection.
You could say online retail now offers a more compelling value to the consumer.
Lower sales at brick and mortar stores forces profit oriented managers to close underperforming stores. Because there are fewer stores in the mall, foot traffic declines. This in turn drives out smaller specialty retailers, repeating the destructive cycle. Fewer stores begets even fewer stores.
Eventually, malls just die.
Interestingly enough, I’ve had a first class seat to this retail trend — I happen to live only a few miles from one of these “dead” malls. It sat nearly vacant for years, with only an occasional “holiday” store, or carnival held in the parking lot. Essentially it became a “zombie” mall — never completely dead, but never able to draw the crowds inside its doors again.
As malls close, the distance consumers travel to shop at physical stores, grows. Online shopping simply becomes the easier option… creating a self-fulfilling prophecy where brick and mortar stores continue to close, and online retail continues to thrive.
Think you’re isolated from this retail disaster? Think again! Hidden within the S&P 500 are many mall owning REITs, including General Growth Properties (GGP), Macerich (MAC), Kimco Reality (KIM), Federal Realty Investment Trust (FRT), Simon Property Group (SPG) and several mall based retailers like The Gap (GAP), and Footlocker (FL).
Even if you invest in index funds, you probably own some of these names.
Most retail stocks are down for the year, and NPR reports that over 90,000 retail employees have lost their jobs since October. Ouch! That’s more than I can count on my tentacles.
But that doesn’t mean all retailers are complete trash. A few are actually doing quite well.
Non-mall based retailers, like Home Depot (HD) , O’Reilly Automotive (ORLY), and Costco (COST) have actually been able to grow sales and still provide enough value to draw physical customers. Freestanding retailers still seem to be doing quite well.
Nobody is suggesting grocery stores are going anywhere either. Amazon’s “Fresh” online grocery store hasn’t yet been able to gain enough popularity to displace them.
This all leads to the conclusion, there are some types of shopping that people prefer to do in person. Groceries, large “white-good” appliances, furniture, and even home improvement stores seem to be immune from much of this retail pain.
Will this kind of retailer be the ultimate retail survivor? Well, it’s hard to say who’s going to survive — the retail landscape is changing far too quickly.
Despite all the hype you hear in the news, brick and mortar retail isn’t finish yet. There will definitely be survivors, but as a category it’s hard to predict.
For every store closed, there will be capital losses, employee severance payments, and inventory liquidated at a loss. The stress on balance sheets and profitability is going to be significant.
It’s going to hurt share prices. Dividends might even be cut! Which is exactly why we recently sold retailer shares in our portfolio.
Yes, I’m A Sell-Out
So yes, we sold our American Eagle Outfitters (AEO) shares recently. I threw in the towel.
Despite posting generally positive sales results with no-debt, good returns on equity, strong insider ownership, decent online sales, and even a growing business, we sold our shares.
I believe this closure trend is just too strong to ignore. Inevitably, the giant wave of store closures is reshaping the retail landscape. This giant wave will catch even the strongest swimmers.
As an investment, AEO wasn’t a winner for us. If anything, we only broke even after years of growing dividends and special dividends. They even paid a growing dividend through the 2008 Great Recession, but all that came to an end recently.
This was a giant red-flag for me– dividends that don’t grow with inflation mean I take a pay cut every year. Couple that with store closures in places where physical stores should have worked, I decided it was time to get out of the retail game.
Anyone who holds retail stocks (even if it’s one of the survivors) should plan on years of “dead money” ahead. Closing stores isn’t cheap, and it will inevitably destroy shareholder equity. Share prices of retailers could be down for years.
Inevitably there will be “survivor malls” in big cities, but I predict the malls in small towns and small cities will close (or simply be redeveloped).
Small towns just can’t drive the foot traffic required for malls to stay open. Physical retail is going to get a lot smaller. It will probably be focused only in urban areas. I guess the great urbanization trend of humanity, applies to retail also.
In the future, instead of operating 1,000 stores globally, a specialty retailer like AEO might only operate 200 physical stores — Just in major cities, essentially becoming a showroom for the online business.
That’s not a transition I want to hold shares through. Capital destruction isn’t my thing. Instead, I plan to re-deploy the money into businesses with growing sales and growing dividends. Afterall, I do have a 2017 dividend growth goal to meet.
If you’re still invested in retail businesses, I wish you good luck over the next few years. Change is often the enemy of good investing returns, and the retail world is definitely a changing place.