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Get In on the Ground Floor for This Retail Meltdown

It was a great holiday season in the retail world – for Mr. Grinch!

As retailers begin to preannounce year-end results, we are learning that the assault on department stores and other traditional retailers from e-commerce, price-sensitive consumers, and a tepid economy continues to batter revenue and profits. Each holiday season it gets a little worse as retailers race to cut prices and downsize faster than consumers flee their venues for the comfort of shopping online. This past year, that trend continued.

Department store sales have dropped $7.2 billion from 2001 to $12.7 billion today, according to BMO's Jack Ablin (and that's nominal, so in inflation-adjusted terms the drop is much more severe). Troubled women's apparel retailer Limited Stores announced last week that it is closing all 250 of its stores nationwide and will try to operate purely as an online company. According to RetailNext, a retail tracking company, sales at brick-and-mortar stores sunk by 10.3% in December compared to 0.4% in 2015. The National Retail Federation expects holiday sales excluding cars, gas, and restaurants to rise 3.6% to $655.8 billion in 2016 with online sales surging 19% to roughly $98 billion and brick-and-mortar sales dropping by tens of billions of dollars.

With numbers like that, it's no surprise that the nation's largest retailers are announcing massive store closings and job cuts. And this store is experiencing one of the biggest meltdowns.

Here's how to profit…

Macy's Is Everything That's Wrong with Traditional Retail

On Jan. 4, Macy's Inc. (NYSE: M) rocked markets with disappointing holiday sales data. The company announced that comparable sales were down 2.1% year over year in the November/December period for licensed plus owned stores, and 2.7% for owned stores. The company was not expecting this news, another sign that management is failing to adjust quickly enough to the changing retail landscape. The department store stalwart has now experienced seven straight quarters of declining sales. Chairman and Chief Executive Officer Terry Lundgren (who has led the company's failed strategy and gone from CNBC "Squawkbox" rock star to soon-to-be ex-chairman and CEO) said, "we had anticipated sales would be stronger. We believe that our performance during the holiday season reflects the broader challenges facing much of the retail industry."

Macy's experienced particular weakness in handbags and watches as specialty retailers continue to take market share from general merchandisers. But an even bigger problem is that Macy's adopted JCPenney's unsuccessful couponing and discounting strategy to chase down-market consumers into the gutter. You can't cut prices to profitability (even Walmart is discovering that).

Mr. Lundgren was correct, however, in stating that Macy's problems are characteristic of an industry under siege from irreversible structural shifts in shopping habits and the economy. Kohl's Corp. (NYSE: KSS), LBrands Inc. (NYSE: LB), Ascena Retail Group Inc. (Nasdaq: ASNA) (Ann Taylor's parent), and JCPenney Co. Inc. (NYSE: JCP) also announced lousy sales last week, and Sears Holdings Inc. (Nasdaq: SHLD) pre-announced another quarter of double-digit same-store sales declines for the holidays.

Virtually all retail stocks took it on the chin with the exception of Sears, where some investors were either duped into covering their shorts and others convinced themselves that by selling one of its few remaining crown jewels, Craftsman, borrowing another $1 billion from its Chairman Eddie Lampert, and closing another 160 stores, the company will somehow reverse years of billion-dollar losses. But Sears stock has since given back all of those gains, so investors weren't fooled for long.

Unlike previous years, however, when retailers could point to one-off factors like port strikes, warm weather, or weaker tourist spending to explain away their bad numbers, this holiday season was unusually normal. Consumer confidence levels were near record highs after the presidential election, there were no weather issues, and companies appeared to have a handle on inventory. Weak sales performance, which is clearly a trend, is due to the structural problems facing department stores: declining traffic, low cost competitors eating their lunch, and the need for heavy discounting to generate sales. This year retailers couldn't blame the environment; the problem is staring them right in the mirror. They need to change their business models to have any chance of turning things around.

Trading signals suggested bad news was coming. The SPDR S&P Retail ETF (NYSE Arca: XRT) saw $230 million of outflows during the last week of December, leaving less than $400 million in the ETF. The Consumer Discretionary Select Sector SPDR Fund (NYSE Arca: XLY) is being heavily shorted as well. Indicators on retail spending were lackluster during the holiday season, which is why none of the news on M, SHLD, KSS, LB, and JCP should have come as a surprise to anybody. But while investors expected poor sales, they were surprised by a disproportionately negative hit to earnings reflected in Macy's and KSS' guidance reductions. They shouldn't have been.

Macy's has been a melting ice cube for a while. Mr. Lundgren is scheduled to leave the company shortly after suffering the curse of being heralded by CNBC as the second coming of retail genius. The only genius in retail today is Jeff Bezos; everybody else is one of his victims, starting with traditional retailers. The company does not expect performance to improve, either. It provided full-year 2016 guidance of a 2.5% to 3.0% decline in same-store sales and reduced its earnings-per-share estimate to $2.95/$3.10 from $3.15/$3.40.

Even more alarming was a second announcement Macy's made on Jan. 4 that it will close 68 of its 730 stores and fire roughly 10,000 employees. The 68 stores are part of the 100 store closings announced in August 2016. Sales will drop by approximately $575 million as a result, and the company expects annual expense savings of approximately $550 million beginning in 2017. The company plans to invest $250 million in growing its digital business and its Bluemercury, Macy's Backstage businesses, and China. Good luck with that.

Sales and profits have been weak at Macy's for the last couple of years. Sales of $17.3 billion for the nine months ended Oct. 29, 2016, were off 5.2% from $18.2 billion a year earlier. Operating income for that period was down 54.7% year-over year (38.3% excluding impairment charges). Net income was off 70.5% for the nine months from $1.56 in 2015 to $0.46 in 2016. The company still has a decent balance sheet and is in no danger of going bankrupt, but is facing an existential crisis of how to remain profitable in the new retail landscape increasingly dominated by e-commerce, more aggressive specialty retailers, and a fast-changing shopping culture. The stock is highly likely to head lower even after dropping sharply last week since the holiday season is now in the rear-view mirror.

I can definitely see the stock moving down to $20 in a year if the company doesn't get its act together and/or the market declines. I suggest you buy long-dated puts on M and get ready for the impending meltdown.

If you're a member of Zenith Trading Circle, you can get my detailed Macy's recommendation here.

Sincerely,

Michael

The post Get In on The Ground Floor For This Retail Meltdown appeared first on Sure Money.

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Prominent money manager. Has built  top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.

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  1. Kurt Gates | January 30, 2017

    Where do you think JCP is heading. Will it turn around.

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