The Storefront Bubble

| About: Macy's Inc. (M)

Summary

While the tech bubble once hurt the retail business, it will be the reason retail thrives once again.

Many publicly traded companies in the retail sector, like Macy’s, have become undervalued due to the effects of technology and online stores and speculation of further decline.

There will always be a need for physical retail locations, thus making a solid investment in large blue-chip retailers.

Is the tech bubble reaching the end? The NASDAQ composite, heavily weighted with information technology companies, returned 1200% in the past 26 years but has remained stagnant with a near break-even return in the past three years to date. Historically, this tech boom indicates an outperformance factor of nearly 2.5x the S&P 500 and Dow Jones indices. Well folks, I believe there is about to be another bubble, largely the result of this technological boom.

Obviously, the tech bubble has devastated the retail sector. Many retail stores such as Pac Sun, RadioShack, American Apparel, Blockbuster, Borders, and KB Toys have already filed Chapter 11. The majority of retail stores that remain have been forced to compete online in attempt to supplement brick-and-mortar stores and provide the best user-friendly experience, lowest prices, and largest selection. These same businesses have seen continuously decreasing revenues from their storefront locations and as a result have had to shut down some of their unprofitable locations. I believe that the tech bubble drove down the value of the retail sector to the extent that many companies with operating profitability are significantly undervalued.

Macy's (NYSE:M) for example, is trading near its lowest point in five years. Currently at $36.46 a share as of Monday's close, the company's stock has fallen almost 50% from its 52 week high of $70.32. Although its revenue has steadily declined for five straight quarters due to many factors, the company is still highly profitable with over $1B in net income each year. Consequently, the company is only trading at 11.91x its earnings, which is astronomically low compared to many tech giants like Amazon with a P/E of 304.87x and Netflix with 273.94x. In addition, only 3% of Macy's shares are short, down from earlier this year, meaning many investors are wary of a further decline.

Furthermore, Macy's gross margin is roughly 38%, which is higher than 81% of it's peers. The company's long term debt has stabilized over the past few years, in the $6.5-7.2B range. To me, this signifies that the company is not currently trying to combat their drop in revenue or a change in consumer trends. Rather, Macy's does not see the short term fluctuations as a long term obstacle.

In addition to the company's solid fundamentals, Macy's currently has no plans to withhold dividend payments. In fact, they recently upped their payout from 0.36 a share to 0.377 in June. With the current low share price, the yield is slightly greater than 4% which is relatively high and on par with popular high yield stocks like Verizon (V:NYSE) and IBM (IBM:NYSE).

Conclusively, Macy's is a solid company that serves as a prime example of a retail store (with an online platform, as well) that can sustain multiple financial crises, changing consumer trends, and the most influential of all: technology (and the rise of online stores).

The online store era, fostered by the technological bubble, is best described through a metaphor in which I will compare online stores to a positive calculus function, with a defined limit. The function (or capability of an online store) will rise quickly at first with a steep slope and continue to grow, but eventually the rate (or derivative) at which the function grows will decline and the function will approach its limit. While the technological limit of online stores is somewhere in the indefinite future, we have already come so close to the limit, that it can be approximated and it would be more beneficial to find areas where the limit is unclear, undefined, and untapped, as with retail stores. On the other hand, declining brick-and-mortar revenues quarter after quarter will begin to cease and approach its limit at which the trend will reverse.Thus, through further evidence I will argue that there is about to be another bubble, possibly larger than the explosion within the tech industry, this time within the retail sector.

First and foremost, there is less competition now that struggling retail companies have already been forced to go out of business. Only the strongest, most substantial and well-built companies that can quickly adapt to the ever-changing environment remain. As a concession, I am not arguing that there are less businesses in the retail sector as opposed to many years ago, but rather many less stores that a company like Macy's would consider relevant competition. Ultimately, consumers are now left with the most viable shopping options and investors are left with the healthiest retail investments.

Secondly, technology (online specifically, with regards to the internet and retail websites) has reached a limit. There will continue to be technological innovations and products and services that increase efficiency, but the potential for a technological advance at the rate we have seen in the past is highly debated. How much better can a website be? Ironic to the purpose of technology and in support of my thesis, there are many arguments and even scientific evidence that simpler is better while more advanced, technology-filled websites are just too complex for consumers to use and ultimately drive away business. I honestly do not foresee internet stores improving at such a rate as they once did. What is there to improve on? I think it may be possible that the algorithms for collaborative filtering improve, but not significantly so that these online websites thrive from it.

On the contrary, investors should think about possible technological improvements within retail stores. Have we seen technological improvements throughout storefronts? Yes, but the focus was not really there. The focus was instead on moving away from storefronts to online sales. However, there are so many possibilities where technology is not limited for physical store locations. Think of automated machines for sorting, price tagging, noting inventory, etc. More efficient cameras and security devices could limit security labor overhead. Automated checkouts could be advanced to the extent that checkout personnel are not even needed. Perhaps, instead of attaching price tags on every item and adjusting each unit to be on sale, customers are given a convenient device that can scan products to see the most accurate price. There are so many opportunities that exist in improving storefronts. I'm sure some of the aforementioned ideas exist, but can be vastly improved upon while a website domain cannot. These ideas are the product of 30 seconds of brainstorming; imagine a team of professionals actually designing and implementing some brilliant features that are well thought out in advance.

Think of the limitations of shopping online, especially within the grocery business. Yes, it's convenient to order groceries online sitting at a computer, but it's inconvenient to search the catalog with thousands of products and hundreds of different brands that offer a specific product. From there, consumers cannot easily read the label and find details on a product without spending an enormous amount of time clicking through the website's pyramid. It might be nice to be able to save a list of groceries to order at a later date with one click, but the average consumer will not typically order the same goods (such as deodorant or olive oil) for every delivery. This process becomes very time consuming especially when creating a new or revising an existing order. Lastly, consumers do not have access to goods immediately; they have to wait for delivery and hope their order is correct and expiration dates suffice. For these reasons, retail grocers will always exist and continue to produce great revenue. It's simply easier (and usually cheaper if the online service charges for delivery) to go to the grocer on the corner and pick out the items yourself.

With regards to apparel and accessories (perfume, handbags, jewelry, etc.), consumers will always want to test or try on the product in person. Of course, many consumers purchase these products online without testing or trying on in advance, but the internet will never be able to make the consumer fully satisfied with their purchase, whereas in store purchases can dismiss any doubts. Lastly, shopping for clothing and accessories has always been a tradition and many consider it a hobby. I doubt that all shoppers will migrate towards the internet, and I would argue that a large majority of consumers that would shop online already are. Thus, online sales will not continue to grow significantly. Consequently, retail stores now have the opportunity steal back the audience of online shoppers, just as technology and online stores stole the interest of physical shoppers once before.

The technology boom was fueled with an enormous amount of hype. That time is over. Online stores have reached their potential, and now it is time for retail stores to catch up. As soon as investors realize that many retail stocks are undervalued, the hype will begin in retail which will drive the market forward once again.

For the purpose of this article, I use Macy's as an example of a retail store that originally focused on generating revenue from their brick-and-mortar locations. I cite this company specifically because I am familiar with its fundamentals. While I am personally invested in Macy's, I think it is important to do thorough research and use the concept of the storefront bubble as a guide to diversifying your portfolio. Ask yourself: Is it possible that many retail stores are undervalued because of the tech bubble? Have retail stores yet to see the worst? Will retail stores ever become obsolete? Is it possible that in the near future these retail stores will have a competitive advantage over online sales because of in-house technology?

Disclosure: I am/we are long M.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I own a small share of Macy's in my personal account for the purpose of diversification and exposure to the retail markets.