Brick And 'Martyr:' Trading The Retail Apocalypse

Summary

• Here's a sector that's on life support.
• And here's how you can trade it before someone pulls the plug.
• Now let's see what readers are more prone to criticize: the trade idea(s) or the thesis itself.

This should be fun.

I'm going to try an experiment which will invariably go horribly awry and lead to all kinds of commenter shenanigans.

If you own brick and mortar retailers, you should get out. Run for the hills. Sell it all.

Why? Simple: The model is dead. Or, if it's not dead, it's on life support. And the proverbial plug will be pulled in relatively short order.

I remember years and years ago, people used to go to Target for fun. Literally.

It even used to have a cute nickname amongst the "in-crowd" of popular high school seniors and female college freshman outfitting their dorm rooms. They called it: "Tar-jay" or "Tar-zhay."

When was the last time you heard anyone say: "Hey, you wanna go to Target and just wander around?" For me it's been about a decade.

But moving beyond the anecdotal, recall the common sense assessment I outlined earlier this month in a post that introduced the "cheezburger cat" as the latest addition to the Heisenberg cast of characters:

Anyone who's been paying attention over the past six or so months is also acutely aware that there's another sector of the US economy imploding: retail (NYSEARCA:XRT). Retail's troubles are well documented. The rise of online competition and a steady decline in foot traffic and earnings seem to presage a veritable apocalypse for brick and mortar. And gain, that's not hyperbole. This is an existential crisis. Just ask any analyst that covers the space.

And while this is one of those cases where some of the "losers" (brick and mortar) will be replaced by "winners" (e-commerce), this is still a major concern.

It really is that simple for brick and mortar or, as I like to call it in a nod to its impending demise, "brick and martyr."

The thing about this space is that when you go looking for data, the story just gets worse, and worse, and worse.

For instance, BofAML recently (and this is a quote from a note out this week) "chalked up the [61,000 retail jobs that were lost over February and March] to a slowdown in consumer activity on weak demand for seasonal goods."

In other words: "weather."

Well on second thought, they determined that that assessment was too anecdotal, so they decided to do a "deep dive." Here's what they found:

Since October 2016, employment has been steadily declining in two retail sectors: general merchandise stores (which includes department stores) and sporting goods, hobby, book and music stores (Table 1). We have seen a similar story in BofA on USA which we publish on a monthly basis. According to Bank of America aggregated credit and debit card data, we see considerable weakness in card spending in department stores (Chart 1). We suspect that these sectors are being weighed down by increased competition from online retailers who have gained significant market share.

Look at that chart! I don't know if I've ever seen something that looked so ominous when you consider how the rest of the chart looks (that is, look at the decline during the crisis - it's a much steadier looking dip, indicative of an economy-wide malaise as opposed to what looks to be an out-of-the-blue collapse more recently).

I mean the outlook is just universally bad and admits of very little in the way of "alternative facts" (so to speak). It's just the same, straightforward, dire narrative no matter where you source it. Here's a random bit from a Goldman note dated March 21:

Our outlook for department store equities has become even more negative following the holiday season as our equity analyst lowered FY17 EPS estimates for JWN, KSS and M. Secular challenges, including declining physical store traffic, increased price transparency, and channel shifts to other formats should continue to pressure results and we expect negative EPS estimate revisions toward our forecasts to drive further downside to stocks (average 14% downside to GS Equity price targets). We are similarly cautious on department store credits in aggregate.

And here's BofAML again:

Beginning of the end. Department stores and the like have been under pressure from ecommerce competition as consumer preference has shifted towards "experiential" shopping. Since 2000, ecommerce retail sales has been growing on average 4.8% per year, well above the industry's average growth rate of 0.8. Also, traditional retailers are adapting as well. As Lorraine Hutchinson's equity retailing team highlights, the declining sales at brick and mortar stores has led to major retailers announcing significant number of store closures and to focus on innovating and integrating different methods of shopping such as online or by phone (i.e. omnichannel).

Now I'm sure there's some nuance somewhere. That is, if I wanted to go digging around through analyst notes on individual retailers I'm sure someone, somewhere will have come up with a list of reasons not to throw in the towel completely.

Similarly, I'm sure there's some data you can find at the macro level that doesn't paint quite as gloomy a picture, but this kind of reminds me of the BlackBerry saga. Remember that? Everyone trying to come up with excuses when the common sense reality was that the company's product had been relegated to the dustbin of history. Same thing here: Brick and mortar is over.

But here's the thing, some of the individual credits aren't trading much like names that are part of group that's experiencing "the beginning of the end" (to quote BofAML). Look at this chart which compares CMBX 6 tranches (BBB- has been the short du jour) spreads to spreads on corporate credit retail names:

(Goldman)

Look at the gap between the dark blue solid line on the bottom and the gray/red lines. That doesn't make a whole lot of sense.

Now to be sure, CMBX 6 has a lot of mall exposure - that's obviously bad in the current environment. Specifically, the breakdown by series looks like this:

(Citi)

So you might say, "well Heisenberg, you can't compare spreads on the broad corporate retail space with CMBX 6 because malls are overrepresented." Or, more simply: "of course spreads on CMBX 6 are wider."

That's where the blue dotted line in Exhibit 1 comes in. The dotted line is basically the retail sector minus companies that are not, to quote Goldman, "typically associated with the 'death-of-the-mall' theme." In other words, you've stripped out the names that are insulated from the mall death spiral. Names like Home Depot (HD), Lowes (LOW), Costco (COST), and Wal-Mart (WMT).

And yet the picture doesn't change much. That is, even ex-HD, LOW, COST, TGT, and WMT, retail sector corporate spreads are significantly tighter than CMBX mezz spreads. That's an exploitable mispricing. Or at least it looks that way.

Now obviously there are some caveats here, but in the interest of not boring you too much, let me just say that I don't like that discrepancy. As a reminder, here's a list of individual names Citi recommends buying protection on if you want to express a directional view (in yellow):

(Citi)

Or, you can short CMBX 7 BBB- which, as you can see below, is probably trading far to tight versus CMBX 6 BBB- considering there's not much difference in the underlying deals (right pane):

(Goldman)

So there's your "actionable" post on what's looking more and more like a complete wipe-out for brick and mortar retailers.

I'll be interested to watch the comments here as readers try to figure what to criticize: a trade they don't understand or the overall thesis.

Have fun. I'll bring the popcorn.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.