Death by Amazon

The Accelerating Change of the Retail Landscape, blog from Jean Rosenbaum, CFA, Portfolio Manager

The recent announcement by Macy’s that they will be closing 100 stores is a rational reaction to the changing retail dynamics. For professional store shoppers like my mother-in-law, the news was quite unwelcome! However, the reduction of a high cost infrastructure is likely to continue as consumer buying habits change.  This trend will ultimately be positive for sales and earnings growth longer term, but getting there could be quite painful for management teams and shareholders.

The price action of the various retail segments foreshadowed these changes. While we have all known Amazon (the ecommerce powerhouse) has significantly outperformed the S&P 500 since going public, the stocks of store based retailers have only recently begun to underperform the S&P 500.  Investors have been well rewarded for embracing fundamental change in retail.  The Bespoke “Death by Amazon” index, which includes a number of traditional retailers, is down close to 28% vs the S&P 500 over the last two years, while Amazon has outperformed the S&P by almost 200%.  The changing landscape is also impacting the mall operators.  An index of mall REITs is down 34% during the same timeframe as their customers, the retailers, have begun to struggle in terms of sales.

The stock performance of the “Death by Amazon” index foreshadowed the significant weakening of fundamentals for the group. While the stocks peaked in 2015, fundamentals did not peak until 2016.  In early 2016, same-store sales growth began to slow and EPS growth turned negative in mid-2016.  Sales and earnings growth could remain a challenge for some time as the move to e-commerce has not been fully embraced.

Online sales frequently have lower profitability, limiting the retailer’s ability to offer free shipping without putting significant pressure on margins. Store and online inventory systems may not be integrated, causing retailers to invest in duplicate inventory.  IT infrastructure to meet the demands of the increasingly mobile consumer base may need further updates.  Solving these problems requires higher capital spending. Profitability will remain under pressure as lower margin online sales become a higher percent of the business.  Supporting online sales while carrying an increasingly less productive store base creates a very challenging situation for management teams that are being asked to increase sales and earnings.  

The rationalization of the store base is a logical response. This trend will ultimately be a positive for store based retailers in the long term as they work to stabilize and ultimately grow earnings.  However, the transition period could be painful due to higher capital spending requirements and to pressure on profitability.  Some retailers may be unable to adapt and will go bankrupt.  Mall operators face “collateral damage” as retailers reduce their square footage and pay lower rent, leading to potential cash flow problems.  Fundamental change is difficult for managements and shareholders, but by focusing on the winners, shareholders can be rewarded with significant outperformance.