Well, um, actually a pretty nice little Saturday - we're going to Home Depot. Yeah, buy some wallpaper, maybe get some flooring, stuff like that. Maybe Bed, Bath & Beyond, I don't know - I don't know if we'll have enough time.
- Will Ferrell as "Frank The Tank" in Old School
Last Saturday was a beautiful day in Chicago - sunny, mid-fifties, a bit of springtime in the air. And like Frank the Tank, I headed out shopping with my wife (though anticipation of our experience didn't lead me to go streaking the night before, fortunately for all).
Our first stop was a mall in the near Northern suburbs of Chicago: Old Orchard, owned by Westfield Corporation (OTCPK:WFGPY). The property is a nice indoor/outdoor anchored by a Macy's (NYSE:M), Nordstrom's (NYSE:JWN), Lord & Taylor, and Bloomingdale's, along with a movie theater, Buffalo Wild Wings (BWLD), Apple Store (NASDAQ:AAPL) and myriad other stores and restaurants (144 in total, according to Westfield).
We had two stops (Macy's and Helzberg Jewelers), and our stay was about 35 minutes, 20 of which were spent in Macy's trying to find an e-commerce return. Truthfully, it didn't occur to either of us to visit the rest of the mall, in large part because my wife does most, if not all, of her shopping online. That isn't necessarily unusual; Macerich (NYSE:MAC) CEO Art Coppola, on his company's Q4 conference call, highlighted internal research that found shoppers were making more frequent but shorter visits, with many of those trips likely similar to ours (picking up/returning e-commerce orders).
And that's a problem: the point of malls is an old-school version of the "network effect", where visitors to one (or a handful) of stores would pass (and browse or buy) at neighboring outlets. Truthfully, it never occurred to us to do so, even on a nice day for an outdoor walk. What was most noticeable was that we hardly seemed alone: the mall was empty, on a late-March Saturday morning with nice weather (although not quite nice enough to head to the lake or spend the day outside), a perfect day for shopping.
Apparently, many people in the area agreed that it was a perfect day for shopping; they simply were somewhere else. From the mall, we went to Home Depot (NYSE:HD) and then Abt Electronics, which has gone from a small family-owned store to a massive multi-product outlet (it even includes a section full of Apple products). Both were packed, to the point where it was difficult to find a parking space.
I've always been a bit skeptical of using anecdotal experiences in investing, and I don't think one visit on one day in one market by two people who don't much care for shopping to begin with necessarily implies the end of a retail era or illuminates some heretofore unknown truth about the space. But the day seemed to support what the numbers show: mall retailing is fading. Traffic is down, and mall retailers are barely showing growth (at best). The best-performing companies in the space - think American Eagle Outfitters (NYSE:AEO) or Express (NYSE:EXPR) - are getting low-teen earnings multiples, and even those look aggressive from my standpoint. Brick-and-mortar retailers generally need 2-5% same-store sales to leverage occupancy costs; that's difficult, if not impossible, to achieve consistently with traffic declines (which seemingly every retailer in the space is facing). Flat sales and occupancy deleverage essentially negate the possibility of any consistent earnings growth; and the lack of consistent earnings growth should (in theory) negate any sustainable multiple even at a zero-growth 12-13x.
I don't think that lesson quite has sunk in with a lot of retail stocks; no doubt, 3%+ dividend yields at stocks like AEO, Gap Inc. (NYSE:GPS), and Guess (NYSE:GES) have something to do with that. But it appears mall owners are preparing for a grim future; PREIT (NYSE:PEI) received applause for selling properties at a 17-18% cap rate this week. Macerich and Westfield are moving as quickly as possible toward the high end of the space, with the idea that destination centers (backed by destination brands) can provide "fortress" income, to use Coppola's phrase.
That was the lesson crystallized by last weekend's trip: the importance of 'focus' in modern retailing. Consumers don't "go shopping" anymore; they go to a store. That's one reason why I'm still bullish on GameStop (NYSE:GME) despite its substantial mall exposure: it's not a store that requires mall shoppers to come in and make an impulse buy. It is a store that gamers go to, which more often than not happens to be located in a mall.
But unfocused stores simply don't attract shoppers in the modern age, and the nature of online shopping may have something to do with that. There aren't really any online malls of note; even Amazon (NASDAQ:AMZN) isn't suited for browsing (it's actually a mind-numbing process, given the selection). We have a decent amount of funds in a Macy's gift certificate after we registered there for a wedding; as I walked around the store while waiting for my wife to finish our return (which took quite a bit of time, as noted; the associate told us a switch to Windows 10 had wreaked havoc on employee tablets), there really wasn't anything of interest. There was a little bit of everything; but not enough for me to consider going back to Macy's, or even to get excited about spending what is basically free money.
The distinction between the mall and Home Depot and Abt was very clear; and it's equally clear that mall owners themselves already have made that distinction. But valuations in the space don't appear to reflect that divergence, at least not in full. A high-teen cap rate is a stunning figure; it reflects a single-digit FFO multiple, and thus sharply declining earnings going forward. But undifferentiated mall retailers - those that aren't destination shops - still are getting low teen multiples, despite the fact that the companies that own their real estate are trying to sell that very real estate to eliminate their exposure to those retailers. Certainly, the REITs that own American retail space are pricing in earnings declines at mall retailers at a rate far higher than that implied by the public markets. And the enthusiasm for turnaround plays in the space - Abercrombie & Fitch (NYSE:ANF) seems a prime example of overoptimism in the equity markets, though its international potential does make it a bit of a special case - makes little sense from my standpoint.
I still think there are short opportunities in the mall space; I'm short GPS and have been trying to find the right time to do the same with Finish Line (NASDAQ:FINL) despite the enthusiasm in the sneaker industry. [That does step a bit outside the "destination" argument, but with FINL a clear second to Foot Locker (NYSE:FL) and Nike (NYSE:NKE) building out its DTC business, I see that "destination" benefit fading, and FINL's valuation is dearer than most of its mall-heavy peers.] Because there doesn't appear to be a catalyst to reverse declining mall traffic. It's not just a matter of online shopping; there are great retailers out there, who can manage e-commerce through either protected markets [Tractor Supply (NASDAQ:TSCO) is one example] or through a careful omnichannel strategy (HD seems to have done well on that front).
But those retailers have clear, compelling reasons to go to the store (or the online storefront), and that seems a requirement for modern shoppers. "Going shopping" simply doesn't interest consumers the way it used to, and without that browsing traffic, I don't see how mall retailers, in particular, deserve any double-digit multiple, to be honest.
As far as Macy's goes [and the same for JC Penney (NYSE:JCP), although Nordstrom's higher-end clientele may provide it some protection], I'm skeptical. There is a new bull case driven by the value of the company's real estate (catalyzed by activist Starboard Capital), but there have been a lot of real estate- and asset-based bull cases in the ZIRP environment, and many haven't played out in practice as they did on paper. [Yahoo (YHOO) and Bob Evans Farms (NASDAQ:BOBE) are two good recent examples.] Real estate monetization is simply asset-based leverage, and while using real assets as collateral is helpful from an interest rate standpoint, levering up a declining business seems a difficult way to create shareholder value. And I still don't see how, in this environment, Macy's is anything but a declining business over the mid- to long-term.
I admit that none of this analysis is particularly unique; the issues surrounding mall traffic and brick-and-mortar retailing more generally are no surprise. But the starkness of the contrast between an empty mall (and a seemingly emptier Macy's) against the jam-packed stores we went to next highlighted, to me, just how big the gap within retail has become. I don't think the gap is going to narrow - and I don't think, within the retail sector, it's yet been priced in.
Disclosure: I am/we are short GPS.
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 may short FINL this week.
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