By Kris Rosemann
Department stores have had a rough go of it lately.
Consumers have turned their attention to niche stores that sell branded products at material discounts, and online shopping continues to be a draw. The holiday season did not provide as strong of a boost as some retailers have been used to due in part to the unseasonably warm weather across the northern US. Macy’s (M), for example, expects that 80% of the year-over-year decline in its comparable sales numbers in the November/December period can be attributed to weakened demand for cold-weather goods.
Investors have taken note of the changes in consumer preference, leaving major department stores to contemplate material changes to their businesses, and the tough sledding the group has endured could lead to unprecedented levels of strategic consolidation and reorganization.
Some smaller department stores have turned to private suitors. In December 2015, Sycamore Partners acquired Belk, a Southern retail chain with approximately 300 stores, for $3 billion. The private-equity firm has since approached another regional chain, Bon-Ton Stores (BONT), about the possibility of combining with Belk. Bon-Ton operates ~270 stores primarily located in the Northeast and Midwest US. The firm has just under $3 billion in sales annually, but has been unprofitable for several years now; shares have fallen more than 80% from 52-week highs in April 2015.
Kohl’s (KSS) has also found itself front and center at the rumor mill, after it was reported that the firm was considering going private or even breaking up the company. Executives are growing concerned that the more than 40% drop in shares that has taken place in the past year will attract activist investors. Management is open to a strategic review and is expected to continue to explore multiple options. Kohl’s has shot down the idea of a sale to private-equity suitors in the past, despite interest being present.
However, a private offer for Kohl’s may be a best case scenario for shareholders, given the rollercoaster shares have been on over the past year and considering the changing consumer environment where the effectiveness of large department stores is being questioned.
Macy’s was also not spared the pain in retail in 2015, as its shares have lost nearly half of their value from highs in July. Comparable-store sales on an owned and licensed basis are expected to fall by 2.7% in the fiscal year, which ends January 31, and management has cut its annual diluted earnings per share guidance to the range of $3.85-$3.90 from $4.20-$4.30. This revised guidance range excludes expenses related to cost initiatives and asset impairment charges, which are expected to be approximately $200 million in the fiscal fourth quarter.
The turmoil Macy’s has experienced in fiscal 2015 has caused the firm to take serious actions in the reorganization of its business. Most notably, management has stated that it will close 36 underperforming stores in early 2016 while reorganizing the remaining stores into 5 geographical regions instead of 7. It will also adjust staffing to a level that is more consistent with recent sales volume. Back-office simplification and reorganization will be undertaken, and the company plans to consolidate its four credit and consumer services centers into three centers.
These cost efficiency and process improvement measures are expected to generate annual SG&A savings of ~$400 million, beginning in 2016, and a target of a $500 million expense reduction, net of growth initiatives, has been set for 2018. The firm has also set a goal of attaining a 14% EBITDA margin over time. Macy’s also has been exploring the possibility of a joint venture with other retailers as it is focused on monetizing its real estate assets in a manner that is consistent with its overall strategy.
Shares of Macy’s and Kohl’s are starting to look cheap after their big slides in 2015 and the time is nearing to scoop up some quality names at a discount, but we continue to exercise patience. We’re going to stick to our methodology over everything, which benefits from a technical margin of safety (share price strength). This “margin of safety” keeps us from catching falling knives, and there is little telling us that both Kohl’s and Macy’s couldn’t still be just that at the moment.
Please be sure to access the 16-page valuation and dividend reports of firms mentioned in this article.