After some poor holiday trading updates, investors have fled the U.S. retail sector in droves in the past few weeks extending the exodus from retail stocks that has been ongoing for around six months.
For contrarian investors, this exodus has thrown up an interesting opportunity. Shares in retailers such as JCPenney Co. Inc. (JCP, Financial), Kohl's Corp. (KSS, Financial), Dillard’s Inc. (DDS, Financial), Macy’s Inc. (M, Financial), Sears Holdings Corp. (SHLD, Financial) and Nordstrom Inc. (JWN, Financial) have fallen to 52-week lows and are now trading at relatively appealing valuations.
Indeed, all of the stocks mentioned above are trading at price-book (P/B) ratios of less than 1.5 and EV/EBITDA ratios of 7.5 or lower.
The big question is, are these stocks worth buying as value plays or are their low valuations warnings for investors to stay away?
Value plays or value traps?
Avoiding value traps is one of the primary jobs of the value investor. Value traps can be hugely detrimental to your long-term performance, especially if you average down while holding. Companies facing enormous structural changes within their industries are more likely than most to end up as value traps, and this is what is happening to U.S. retailers. The U.S. retail industry is changing dramatically, and traditional brick-and-mortar outlets cannot change fast enough to keep up.
This holiday season really hammered home to managements how quickly the industry is changing.
For example, Sears reported that its holiday sales declined 12% while Barnes & Noble (BKS, Financial) reported its comparable same-store sales fell 9.1%. Few other retailers fared better. In response to the sales decline these retailers are slashing the number of outlets they operate across the U.S. At the end of last week, Sears announced plans to cut another 150 stores while Macy’s has announced plans to cut 100 stores, warning that job losses could top 10,000. These cuts are all part of the companies’ plans to “right size” their physical footprints while investing in their online offerings.
Simply put, these retailers are shrinking, and for this reason it's hard to try and put a value on the shares. By shrinking their physical footprints U.S. retailers are being dragged into a wall with Amazon (AMZN, Financial), which already has a massive head start. Even though this is a downward spiral, retailers don’t really have much choice in the matter. Amazon is simply too big to compete with, and shoppers are shopping more and more online.
What’s more, as both Edward Lambert and Bill Ackman (Trades, Portfolio) have discovered with Sears and JCPenney, it is basically impossible to try and turn around a traditional retailer by using standard turnaround techniques such as cost cutting and asset sales. These two investors, who have had some success in turning around other operations during their careers, appear to have only made the problems at JCPenney and Sears worse by cutting costs and closing stores.
If former Wall Street stars Ackman and Lambert can’t turn around retailers, what chances do the retailers themselves have? Both Ackman and Lambert had access to billions in fresh capital and some of the best consultants and advisers in the retail business, but they still failed.
The bottom line
By taking an objective view and looking at the U.S. retail sector without any position, it is clear that the industry is suffering from some serious problems, problems that won’t be cured just by shutting shops and moving online. Stores are the one advantage traditional retailers have over online retailers such as Amazon; if Macy’s and Sears close their brick-and-mortar stores they are essentially cannibalizing themselves accelerating the trend online. Customers will not seek out the Sears Web site over Amazon, which offers a greater variety of products at lower prices.
Ultimately then, with such significant structural issues facing the U.S. retail industry, it looks as if the sector is a value trap.
Disclosure: The author does not own any share mentioned.
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