Mall Retail Armageddon?

We think investors should be extremely cautious if they are interested in any mall retailers. Mall REITs are starting to feel some of the pain, too.

By Brian Nelson, CFA

Our latest channel checks at the malls foreshadowed what eventually turned into a terrible showing during the first quarter for the department stores such as J.C. Penney, Kohl’s and Nordstrom, but the apparel names and other niche shops are feeling the pain, too. It is becoming eerie when visiting the malls these days. In some of the locations we’re visiting, hardly anyone is there! Generation Z may not pick up the slack from the millennial generation, and it is showing up in the numbers big time. Here’s a run down of how things look at the department stores:

J.C. Penney (JCP): Our fair value estimate range for J.C. Penney at the low end is $0. We don’t think J.C. Penney’s equity will make it to the other side of the economic cycle, and shareholders of the firm today are holding a lotto ticket, and it is not likely to pay off. The company’s first-quarter results, released May 21, showed revenue falling by 5.6% (comp sales dropped 5.5%) and non-GAAP loss per share of $0.48 (-$0.48) missing expectations. Adjusted EBITDA came in at $74 million versus consensus expectations of $99.5 million and a mark that surpassed $150 million in last year’s quarter. Management expects to be free cash flow positive for fiscal 2019, but we don’t see it happening. The company has already burned through $276 million in the first quarter, despite cutting capital spending more than 30% from the same period last year. Though there may be some value in the strategic positioning of its real estate, we can’t see the investment case for J.C. Penney. View J.C. Penney’s stock page >>  

Kohl’s (KSS): The department store industry has its back against the wall, and our latest channel checks were somewhat frightening, Latest Channel Checks at Malls…Scary. Shares of Kohl’s were crushed after it reported first-quarter results May 21. Revenue dropped 2.9%, while net income fell 17% during the period, and management noted that “the year has started off slower than we’d like, with…first-quarter sales coming in below our expectation.” It seems like our channel checks were spot on. Kohl’s is excited about its nationwide rollout of its Amazon returns program, but the core business remains under pressure, with it reducing earnings per share guidance for the year to the range of $5.15-$5.45 from $5.80-$6.15 previously. Many may be attracted to the firm’s mid-single-digit dividend yield, but please be careful. Its Dividend Cushion ratio was already below 1 prior to the guidance cut, and we expect a downward revision. We think shares are about fairly valued at the moment, but they look to be most likely en route to the downside of our fair value range ($44). View Kohl’s stock page >> 

Nordstrom (JWN): We had talked about the troubles anchor store retailers in malls are encountering, and Nordstrom was no exception. Following disappointments from J.C. Penney and Kohl’s, perhaps Nordstrom’s first-quarter report, released May 21, which showed misses on both the top- and bottom-line, shouldn’t have been that surprising. The market still drove shares down more than 9% during the trading session May 22, however. The commentary was flat out “scary:” While (Nordstrom) expected softer trends from the fourth quarter to continue into the first quarter, (it) experienced a further deceleration.” Again, this was consistent with our channel checks when we were flat-out surprised at how empty some of the malls were these days. For fiscal 2019, the company cut its revenue outlook to -2%-0% (was +1%-2%) and its earnings per share outlook to $3.25-$3.65 (was $3.65-$3.90). We view Nordstrom as “uninvestable,” much like the rest of department store retail. We plan to adjust our fair value estimate lower on the news. View Nordstrom’s stock page >>

The poor performance from department store retail came alongside rather weak results from Children’s Place (PLCE) and Guess (GES). There were some bright spots in retail from Estee Lauder (EL) and V.F. Corp (VFC), and it’s hard not to like how Best Buy (BBY) and Target (TGT) are holding up, but for the most part, those tied to mall retail seem to be in whole lot of trouble. We know the secular trend against mall retail has been in the works for a while, but it looks like things may have really accelerated to the downside, if only in the past few quarters.

The trading session May 29 was rough for a large number of mall retailers, “with the damage running from high-end sellers to teenager mail chains.” American Eagle Outfitters (AEO), Capri (CPRI) and Canada Goose (GOOS) were the culprits, but the sell-off was widespread. Abercrombie & Fitch’s (ANF) report, released the same day, showed a comp sales miss and drove shares down by the mid-teens during the trading session. This comes after “more than 7,150 store closures this year…announced by U.S. retailers including Dressbarn, CVS (CVS), Party City (PRTY) and Pier 1 (PIR), according to Coresight Research.”

The bloodbath continued. J. Jill (JILL) reported weak first-quarter results May 30 that management described as such: “We are disappointed with our first quarter performance and are taking immediate actions to clear excess inventory and position the business for improved results in the second half of the year.” The stock was cut in half during the trading session. After the close May 30, Gap (GPS) announced that its first-quarter comparable store sales fell 4% missing the consensus estimate considerably. The company called the most-recently completed quarter “extremely challenging” and lowered its outlook for comparable store sales for the year.

It should be no surprise that we don’t like mail retail at all, and we’re watching the mall REIT space closely, too, namely shares of Simon Property Group (SPG), Macerich (MAC), Taubman Centers (TCO), CBL & Associates (CBL), PREIT (PEI), Washington Prime Group (WPG), and Kimco (KIM). We’re generally avoiding this space altogether.

Related: FOSL, BOOT, CAL, GIII

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