Jan 6, 2017
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U.S. department store challenges fail to rattle some investors

Jan 6, 2017

Weak holiday sales by some U.S. department stores have reignited fears that the sector may never recover its growth levels of the past, but some investors are holding out hope for a longer-term recovery.

Disappointing sales at Macy's Inc and Kohl's Corp, coupled with store closures and layoffs, triggered a selloff in retail stocks this week.

Competition from fast fashion retailers coupled with a massive migration over to e-commerce are completely upending the department store business model.

Despite the share massacre that prompted a series of price target cuts and stock downgrades, most analysts stayed away from an outright "sell" rating on department store stocks.

Portfolio investors and credit analysts focused on retail are willing to give Macy's, Kohl's and some other chains more time to turn around, citing positive strategic changes in the face of a seismic shift in the sector. Department stores have suffered due to the rise of e-commerce and fierce competition from off-price chains including TJX Cos and fast-fashion retailers such as Inditex's Zara.

"There is optimism that someone will shrink the business enough to hit that magic number and turn it around," said Ken Murphy, senior vice-president and portfolio manager at Standard Life Investments.

Murphy and other investors said strategic changes being executed by department store operators carried promise. This includes investing heavily in boosting online sales, shrinking the number of stores and aggressively cutting expenses.

For example, Macy's said on Wednesday it will shut 68 stores this year, part of a plan announced in August to shutter 100 stores. The retailer said it will invest in increasing its digital business, focus on the off-price retail channel with its "Backstage" branded stores, restructure management and reduce costs.

Macy's shares fell as much as 14.8 percent on Thursday, their biggest percentage drop in seven months, while Kohl's fell as much as 20.5 percent, its biggest decline in more than 14 years.

The dismal showing hurt others like JC Penney Co Inc, which fell 7.2 percent to $7.86, and Nordstrom Inc, which ended down 6.9 percent at $45.56. Other retailers including Sears Holdings Corp, Victoria's Secret owner L Brands Inc and American Eagle Outfitters Inc also reported weak sales.


Jack Ablin, chief investment officer at BMO Private Bank in Chicago, said he was optimistic about a long-term recovery, even though the difficult operating conditions are unlikely to change.

"I don't see how the environment gets much better for these retailers," Ablin said. "But they still have room to execute changes and it will be interesting to see how that helps them."

Other investors pointed to the shifting expectations for what could constitute a retail recovery.

"I don't think these retailers will come back to where they were before or completely turn around their operations, but I do expect them to stabilize the business over time," said Charles Sizemore, founder of Sizemore Capital Management LLC, which owns shares of Wal-Mart Stores Inc and Amazon.com Inc.

Christina Boni, vice president and senior credit analyst at ratings firm Moody's, shared the optimism: "2017 will be another year in that journey of finding that right balance for these chains."

"There will be a time when this shift from store to online will start to equalize and these businesses will find an equilibrium," she said. Off the 22 analysts covering Macy's, 18 have a "hold" rating, one has a "buy" rating and three have a "strong buy" on the stock. Of the 23 analysts covering Kohl's, 13 have a "hold" rating, five have a "strong buy," one has a "buy" and four rate it a "sell," according to Thomson Reuters Eikon.

"Going forward, we do not anticipate a change in the weak traffic levels witnessed across the retail industry," Telsey Advisory Group said in a note to clients on Thursday. The company cut the rating on Kohl's from "outperform" to "market perform."

Despite these weak performances, analysts expect the recently concluded holiday shopping season to be a strong one for U.S. retailers, helped by higher wages, low unemployment and falling gasoline prices.

The National Retail Federation has forecast that 2016 holiday period sales will rise 3.6 percent to $656 billion. The final figures are expected later this month.


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