Retail Apocalypse Also Creates Winners

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by: Kevin Carter
Summary

Thousands of stores are closing in the U.S.

Part of this is changing consumer tastes in an overbuilt retail space.

The retail shakeout has created winners along with losers.

Emerging markets have "leapfrogged" over the traditional retail model and are embracing e-commerce.

Much has been written by the retail apocalypse. Thousands of retail stores across the nation are being closed. While the situation may seem dire, the reality is that the retail industry is adjusting to the changing tastes and behaviors of the population. The confluence of a new generation of consumers who do not enjoy spending the day shopping only to return home with nothing but who prefer convenience and an overbuilt retail industry have resulted in a rationalization of the retail space. Despite these trends, there have also been winners in the retail space.

Emerging markets have been less affected by the retail apocalypse and offer potential opportunities in the new era of retailing. Countries in the emerging markets have leapfrogged over the bricks and mortar model of retailing and have embraced online retail. Many companies in the emerging markets have realized phenomenal growth in catering to e-commerce in the emerging markets.

Investors can invest in e-commerce companies operating in the emerging markets such as Alibaba (NYSE:BABA). Or they can invest in funds like EMQQ - The Emerging Markets Internet and Ecommerce ETF which invests in e-commerce companies operating in the emerging markets.

Retail Apocalypse

The "Retail Apocalypse" has closed thousands of retail stores and cast many iconic brands into bankruptcy, impelling distressed debt investors to search for the next victim.

According to an article on CNN Money, 2017 saw a record number of store closings. Retailers announced plans to close more than 6,700 stores during the year. This was higher than the 6,183 closed during the height of the financial crisis in 2008. Iconic brands such as Sears (SHLD), Kmart, RadioShack, and J.C. Penney (NYSE:JCP) closed many of their stores. Companies such as Gymboree, Wet Seal, Payless ShoeSource among others declared bankruptcy.

2018 is shaping up to be another dismal year for retailers. An article in BusinessWeek projects 3,800 store closings this year. Toys 'R' Us is in the process of liquidating all of its 735 US stores after an unsuccessful attempt to restructure the business through bankruptcy. Sears and Kmart continue to shed stores among sizable closures announced by Walgreens (NASDAQ:WBA)/Rite Aid (NYSE:RAD) and Ann Taylor.

Some Hyperbole

There are definite changes occurring in the retail industry. However, "apocalypse" is a bit of an exaggeration. The retail world is not coming to an end. But it is evolving.

An article in Investor's Business Daily noted that overall retail sales are up and retail vacancy rates are down. It also noted that employment in the retail industry declined in 2017 and will probably continue to decline in 2018, but unemployment in the retail industry has also declined.

While thousands of stores have closed and thousands more are slated to close, this is just a small percentage of stores in the U.S. An article on Bloomberg estimated that there were over 1 million stores in the U.S. at the end of 2015 (data collection is lagged). Not only that but the U.S. is over-stored. An article on Bloomberg noted that the U.S. had 23.6 square feet of retail space per person versus 11.1 in Australia and 4.6 in the U.K. There are just too many stores, so some need to close. The downsizing of America's retail footprint is likely to continue until it becomes more appropriate relative to market demand.

Creative Destruction

This term refers to the process of how capitalism leads to a constantly changing structure of the economy. Old industries and firms, which are no longer profitable, close down enabling the resources (capital and labor) to move into more productive processes.

The retail apocalypse should be viewed in terms of creative destruction. Consumer's tastes have changed. People don't like shopping in malls or actual stores anymore. Retailers will either have to adapt to changing tastes or go away.

You walk into stores that don't have what you are looking for or that aren't relevant to you and see employees who aren't engaged or excited to be there. Oftentimes, you walk out of the stores empty-handed, frustrated, and feeling like you just wasted your time. These mass experiences with mediocre customer service are exactly what we are trying to get away from.

Instead, we are moving towards personalized experiences that are tailored to our every need. This kind of experience is the opposite of what is available at shopping malls, and they simply can't be delivered by most brick-and-mortar stores. The retail apocalypse is simply an evolution of our society. People can buy almost anything online now and have it delivered within a few days - if not the same day. Why would customers toss that aside to get an impersonal experience at the mall when they can find exactly what they need, tailored to them, from the comfort of their living room or wherever they are on the go?

Instead of thinking of it as the end of the world, we should really be looking at this as the natural evolution of life and business.

Other Factors

One of the causes is that many of these long-standing chains are overloaded with debt - often from leveraged buyouts led by private equity firms. There are billions in borrowings on the balance sheets of troubled retailers, and sustaining that load is only going to become harder - even for healthy chains.

There Have Been Winners Also

Creative destruction also implies that those who adapt to changes in the economy can win. As the consumer has evolved, companies that have been able to evolve have done well.

E-commerce thrived during 2017. An article in Practical Ecommerce noted that "U.S. e-commerce sales in 2017 grew 15.8 percent to $452.8 billion, an estimate provided by research firm eMarketer."

The most obvious example of this is Amazon (NASDAQ:AMZN). Practical Ecommerce reported that Amazon continued to dominate e-commerce in 2017, grabbing 43.5 percent of all U.S. e-commerce sales, up from 38 percent the previous year, according to an estimate from eMarketer. A Forbes article noted that Amazon could be the world's first trillion-dollar company and expects that it will make up half of the online marketplace.

However, many traditional retailers have been able to evolve to changing consumer tastes. A retailer that has done a good job of "harmonizing" the customer experience across physical and digital channels might have kept most of the potential shift away from physical to digital within their corporate umbrella. Neiman Marcus (NMG) and Nordstrom (JWN) - as just two examples - may have struggled to grow comparable stores sales across the last several years, but their e-commerce business has been strong and now accounts for over 25% of total revenues, according to an article in Forbes.

Additionally, while many retailers have been closing stores, there have been other retailers that have been opening stores. In general, many of the new store openings have been discount stores, according to an article in Business Insider. In fact, discount retailer Dollar General (DG) is leading the charge with 900 store openings this year.

Emerging Markets - The Leapfrog Effect

Countries in the emerging markets have a comparatively underdeveloped brick-and-mortar retail sector. The vast majority of emerging market consumers have never owned a car, have never had a big box retail store to drive to, nor have they owned a computer of any kind, let alone one with an Internet connection. Without this traditional consumption infrastructure in place, e-commerce companies are enabling emerging market consumers to "leapfrog" this stage of economic development entirely, moving on to the 21st century patterns of consumption now increasingly dominant throughout the developed world.

As such, retail in emerging market countries may be buffered against the evolutionary changes affecting developed nations. Indeed, these changes may actually be a benefit to the emerging markets.

Summary

The retail industry is facing significant changes as consumer taste shift. Consumers are increasingly turning to online retail outlets rather than shopping in physical stores. As a result, thousands of stores are closing in the U.S. However, companies that have been able to adapt to changing consumer tastes have been able to prosper. Emerging markets may benefit as they are largely leapfrogging the bricks and mortar infrastructure in the developed countries and immediately building out their online presence.

EMQQ - The Emerging Markets Internet and Ecommerce ETF - invests in e-commerce companies in the emerging markets. EMQQ holds companies that are poised to benefit as consumers in the emerging markets ramp up their online spending.

Disclosure: I am/we are long BABA. 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.