Circuit City, RadioShack, Blockbuster and Borders. The names read like an obituary for American retail over the last ten years.
The slow death of traditional brick-and-mortar retail has been one of the clearest trends over the last decade.
The combination of slow economic growth and increasing e-commerce sales has already meant bankruptcy for many department stores and retailers will continue to face hard times.
Investors have time and again been drawn into ‘value-plays’ on the hope of a rebound in retailers and stocks hit by the trend.
Instead of trying to defy the trend, investors need to look for retailers that can survive and thrive within it. I’ve found two companies that will do just that with experience-oriented products that can still draw shoppers.
These two aren’t waiting around to develop their e-commerce platforms either, and in-store demand will help support sales as online revenue picks up.
Rumors Of American Retail’s Untimely Demise Are Not Exaggerated
Holiday spending rose 3.6% in 2016 according to the National Retail Federation, a solid gain over the previous year, but the breakout shows a far weaker picture for traditional brick-and-mortar stores. Most of the increase is due to a 12% jump in online sales compared to just 1.6% growth at physical stores.
And physical stores may actually be celebrating that 1.6% growth.
The Fed reports that retail and food services sales have grown at an abysmally low 0.69% annually when adjusting for inflation over the last decade. At the same time, e-commerce sales have increased from 3.5% to nearly 8.5% of total retail sales.
More people went online for Cyber-Monday this year (109 million) than went out to stores for Black Friday deals (99 million). Strong online sales helped support retailers against a drop of 2.1% in comparable sales at physical stores during the first weekend of the holiday shopping season.
The continuing weakness in physical store sales has prompted the perennial wave of store closings. So far it’s just been Sears and Macy’s, but more companies are likely to follow. Forrester Research estimates that online sales will grow by an average annual rate of 9.3% through 2020. Expectations for weak retail sales overall mean much of that growth will come at the expense of traditional retailers.
Two Retailers That Can Survive And Thrive — Plus One That Can’t
Against the long-term trend to online shopping, investors can still find opportunities in traditional retailers.
Look for companies that are building their online shopping presence and specialty retailers selling experience-oriented products. These are retail products like home furnishings, intimate apparel, and beauty that bring consumers into stores for the shopping experience rather than simply the utilitarian need.
Williams Sonoma (NYSE: WSM) has built a solid brand in the home furnishing market. Despite the fact that the company has done amazingly well online, building its e-commerce business to 51% of sales, I believe it can still do well with brick-and-mortar stores as consumers look for the experience of crafting their dream home. Thanks to the success of online sales, the company has been able to grow sales by 7% a year over the last three without sacrificing its 10% operating margin.
The company has just recently expanded to international markets with stores in Australia (2013) and Mexico (2015). Its strong presence in e-commerce should help it ramp up international sales quickly with minimal investment in physical stores. Shares trade for 14.9-times trailing earnings and pay a 3.0% dividend yield.
L Brands (NYSE: LB) competes in relatively less-competitive specialty markets with its Victoria’s Secret, Pink, Bath & Body Works, and La Senza stores. The company has started to grow its online presence with Victoria’s Secret booking 20% of sales online. Even as more shoppers go online, these experience-oriented shopping brands should continue to draw people into the stores.
The company currently books just 4% of sales outside of North America, leaving plenty of room for international expansion. Sales growth has been stable and the company has been able to improve its operating margin to 18% from 15% over the last three years. Shares trade for just 15.5-times trailing earnings and pay a 3.9% dividend.
Ross Stores (Nasdaq: ROST) has done well with its off-price labels but wage growth this year may mean people start paying up for clothes. Combine this with the recent entry of Macy’s into the off-price market and Ross Stores could see shrinking revenue.
The company has nearly equal amounts of cash and long-term liabilities on the balance sheet but management is planning an aggressive expansion, nearly doubling the store count from 1,500 to 2,500 in the United States, and this could weigh on cash flow at a time when consumer trends are threatening brick-and-mortar stores. The company has virtually no online shopping presence. Shares have jumped 28% over the last year and are now trading for 24.6-times trailing earnings.
Risks To Consider: Higher wages could weigh on retailers, as stronger consumer spending is offset by higher operating expenses in this labor-intensive industry.
Action To Take: Position in experience-oriented retailers and those with strong brands like Williams-Sonoma and L Brands while others in the industry struggle with the shift to online shopping.
— Joseph Hogue
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Source: Street Authority