In what was a long-time coming, Sears looks to finally be succumbing to the pressures of the brick-and-mortar retailing business. It won’t be the last big-name retailer to fail, and it certainly wasn’t the first. Luxury stocks are reeling as a result of worries in China. Financial tech stocks gave back a fraction of their huge gains more recently, as investors size up credit risk at this stage of the economic cycle. We continue to believe financial tech is the place to be, however, with PayPal and Visa as two of our top considerations.
By Brian Nelson, CFA
Sears Holdings (SHLD) is now nothing more than a penny stock, trading at about $0.40 per share, as CNBC reported that the failing brick-and-mortar retailer is working with banks to arrange a bankruptcy filing. We wouldn’t expect shareholders to get much in the event of a Chapter 11 filing, and we think the odds are in favor of equity holders being completely wiped out, despite what could still be considerable value in its real estate holdings, but most of that was already offloaded to Seritage Growth (SRG). The 125-year-old American icon’s fall from grace had been largely telegraphed for years, as losses kept mounting and mounting, regardless of the efforts of CEO Eddie Lampert.
It’s hard to imagine it now, but many thought Sears under the tutelage of Mr. Lampert would become the next Berkshire Hathaway. I never thought this, and I was surprised to see many analysts looking for parallels. Look at this unfortunate piece from The Street (TST) in 2007 as just one example: “Cramer often says Sears, which he owns for his Action Alerts PLUS charitable trust, could be the next Berkshire Hathaway…” Granted, a lot has changed since 2007, but has it? Sears and Kmart are still brick-and-mortar retailers struggling against the likes of Amazon (AMZN), eBay (EBAY), and the digital arms of the more established players such as Walmart (WMT) and Target (TGT), and the outlook never really had a reason to change.
We continue to believe the department store business is in permanent decline. Though Macy’s (M), Kohl’s (KSS) and Nordstrom (JWN) may limp around for years, the best days are behind the group, in our view. JC Penney (JCP), in particular, if it has a disappointing holiday season, may not make it to the other side of this economic cycle, as it, too, is on the brink of failing. JC Penney has tried just about everything, from the Ron Johnson experiment years ago to better free-cash-flow management, but nothing has worked. A business model that is dependent on offering sales coupons and huge discounts to get traffic into the store isn’t going to thrive, and it doesn’t appear that many will survive much longer. We don’t think there is an answer to the department-store dilemma. The downside fair value estimate ranges for Sears and JC Penney have been $0 for some time now.
On October 10, Fastenal (FAST) reported solid fiscal third-quarter results that showed a beat on both the top and bottom line. As one of the largest industrial distributors, the company is now viewed by many as one of the better bellwethers to use in gauging the health of industrial economic activity. During the quarter, Fastenal’s net sales advanced 13% on a year-over-year basis, and management noted that the increase was “related primarily to continued strength in underlying market demand and construction.” It looks like the industrial economy continues to hum along nicely, and while there’s only so much that can be gleaned from just one report, we didn’t see anything in the Fastenal report that would raise any concerns, at least domestically.
Globally may be a different story, however. LVMH-Moet Hennessy Louis Vuitton (LVMHF) reported solid performance in its nine-month release October 10, showcasing a solid 10% increase in organic revenue, but the luxury goods maker’s conference call left a lot to be desired. Investors may have been hoping for more optimistic commentary surrounding the consumer landscape in China (FXI, MCHI), but it appears that prior reports, released by Bloomberg, regarding a government crackdown of travelers returning to the country “with suitcases fill of luxury goods” may be valid. The luxury business is highly dependent on “daigou,” a profitable practice for Chinese tourists that acquire goods overseas and then sell them back home. According to the Bloomberg note, “there haven’t been any official (custom) policy changes in China recently,” but LVMH management did little to assuage concerns on its conference call. Burberry (BURBY), Kering (PPRUY), Richemont (CFRUY), and Tiffany (TIF) may feel some impact.
We think a negative view on credit-card and payments stocks, or financial tech, is a bit premature. Digital commerce is surging and credit-card adoption is still nowhere near saturation. Most of the world still conducts business with check and fiat currency. The opportunity for the group remains tremendous, and while credit risk will always be a concern for the likes of Discover (DFS) or American Express (AXP), Visa (V) and MasterCard (MA) don’t have that problem. We think PayPal (PYPL) and Square (SQ) are still well-positioned long-term, and while cryptocurrency may pose some challenges to the business over the long haul, we view Bitcoin and other cryptocurrencies as more an opportunity than a threat for the group at this time. We remain big fans of financial tech, with Visa and PayPal our two favorites. Square has had a huge run.
Retail – Multiline: DDS, JCP, JWN, KSS, M, SHLD
Luxury Goods – Established Brands: AVP, EL, LULU, NKE, PHG, PVH, REV, SIG, SNE, UA, VFC
Luxury Goods – Ultra & Aspirational: BID, CFRUY, FOSL, KORS, LVMHF, RL, TIF, TPR
Distributors – Industrial: AIT, AXE, FAST, GWW, MSM, WCC
Financial Tech Services: ACIW, EPAY, FDC, FIS, FISV, FLT, GPN, MA, MELI, PAY, PYPL, V, VRSK, WEX, WU
Related: FINX
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Brian Nelson does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.