Retail stocks and the mall and shopping center real-estate investment trusts have been hit hard by investors worried about the impact of online shopping on both retailers and the physical locations where these stores reside.
In particular, the big department stores like Macy’s (ticker: M), JCPenney Co. ( JCP) and Sears Holdings Corp. ( SHLD) that take up a lot of square footage at malls have seen their values plunge, with some stores like Sears teetering on the brink of bankruptcy.
With share prices of many retailer and mall REITs down sharply from their highs, value investors are beginning to get interested. Are there some bargains to be had in the clearance bin, or should investors wait to avoid being stuck on a value trap?
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Market watchers say part of that depends on an investor’s mentality and the individual companies themselves.
Secular or cyclical change? Colin McWey, vice president and portfolio manager at Heartland Advisors in Milwaukee, says when looking at value investments with the idea of a long-term holding, one question to ask is whether a sector is facing a secular change — that is a structural change in how business is done — or if this is part of a business cycle. Retail is facing secular changes with e-commerce hitting physical stores hard, he says.
“You have a space that is grossly over-retailed,” McWey says, noting the U.S. has two to five times the square footage per capita of other developed countries.
Although the U.S. sells more retail per capita, sales don’t offset the square footage. Even as e-commerce appears to be everywhere, he adds that brick-and-mortar retail sales still represent 93 percent of the total U.S. retail sales.
“The fact that 93 percent still are tied to brick-and-mortar stores, there could be a long runway of pain, just from a secular reset from where these sales happen,” he says. “To me, that’s one data point to tread carefully.”
That’s an issue for both retailers and the malls and shopping centers, says Pat O’Hare, chief market analyst at Chicago-based Briefing.com
“When the entire group trades down like that, it’s a reflection of a market that is fearful of a secular change, and until it can get a better grip on things, it’s in a mode of selling first and asking questions later,” he says.
John Snowden, global portfolio manager at Resource Real Estate in New York, says the problems that department stores and malls have with e-commerce isn’t new. While it’s had an impact on the mall and shopping center REITs and the anchor tenants like Sears and Macy’s, he says these stores pay a quarter or less in rent compared to a specialty retailer.
“Although many of the department stores have closed their operations, the regional mall owners haven’t been idle,” Snowden says. “They’ve been backfilling this space, putting in tenants paying three or four times the rent of what the department store does.”
He says mall owners are changing the nature of the mall to make it more experiential, adding more restaurants and movie theaters.
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“If you look at the occupancy numbers over the last one to two years, for the A-grade and most of B-grade malls, it’s been quite high, at 94 to 96 percent,” he says.
Malls are graded based on the amount of money they make in sales and revenue per square foot. The benchmark for an A-grade mall is usually at least $500 a square foot in sales, with B-grade malls around $375 a square foot.
“They have the repositioned their portfolio, but that’s a fact of life,” Snowden says. “The typical mall tenancy mix changes. Twenty to 25 percent of the tenants are churn or replaced over a typical five-year time period.”
Wey, though, isn’t impressed by the arguments that anchor stores weren’t as profitable and the repurposing.
“It’s hard to escape the fact that half of the anchor tenants have negative same-store sales. That tells you the amount of store closings is about to accelerate,” he says. “Even if you take the argument from these mall owners of these anchor tenants not being that profitable, that same analysis if you look at the most profitable retailers in terms of the leases that they pay these mall owners — now I’m talking more niche apparel sellers — their same-store sales trends paints a similar picture to these anchor stores. Either way you want to slice and dice it, the clear sign is that store closings need to accelerate at a much faster clip.”
A stock-pickers market. For Wey and O’Hare, retail and mall REITs aren’t at a place to buy and hold yet, and O’Hare adds this isn’t the time to buy an index fund like the SPDR S&P Retail ( XRT). Instead, O’Hare sees retail stocks as short-term trading opportunities rather than long-term buys where buyers are willing capitalize on quick moves.
Investors looking for longer-term buying opportunities should start by looking at retailers who are increasing their online business, Wey and O’Hare say. One company that’s doing that is Staples ( SPLS), Wey says.
Wey says Staples is valued at nine to 10 times earnings, with zero net debt and a 5.5 percent dividend yield that he considers safe and sustainable. Staples is being valued as a “dying storefront retailer” but 37 percent of the company is store sales, and the other 63 percent is a delivery business, he says, with less than half of its sales coming from office products.
“Over half of it now is non-office related business supplies, from janitor/sanitation to breakroom products,” he says. “They’ve now had double-digit growth in non-office product sales for the middle market for four consecutive quarters.”
Malls aren’t dead in the e-commerce world, Snowden says. He notes some e-commerce providers are setting up operations or delivery points in the malls. Amazon.com ( AMZN), for instance, is starting to open bookstores.
He also agrees investors need to look at quality if they want to buy mall REITs. He likes GGP ( GGP), formerly known as General Growth Properties, which holds a lot of A-grade malls and trades at a discount.
[See: 7 Stocks That Soar in a Recession.]
“They pay a healthy dividend yield of 3.7 percent,” he says. “The quality of their malls is higher and they’re a large $20 billion market-capitalization company.”
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Are Retail Stocks and Mall REITs a Value Play? originally appeared on usnews.com
