With all-too-frequent news of store closings and bankruptcies for physical retail chains like Wet Seal and Sports Authority, it can be easy to buy into the myth that e-commerce is replacing physical retail -- but that's far from the whole story.
On this Consumer Goods episode of Industry Focus, analyst Sarah Priestley and contributor Daniel Kline explain how the physical retail industry is still very much alive and kicking, and what investors need to know about the space. Find out why some retail stores are failing while others are growing, which retailers to watch, what investors should look for to see how well they're handling the transition into the post-Amazon (AMZN -0.97%) retail world, and more.
A full transcript follows the video.
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This video was recorded on April 25, 2017.
Sarah Priestley: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Tuesday, April 25, and we're talking consumer goods and exploring the supposed death of the retail industry. For today only, I'm your host, Sarah Priestley, and joining me in the studio all the way from sunny Florida is our Motley Fool contributor Dan Kline.
Daniel Kline: Hey, Sarah! We've been talking about doing this for over a year.
Priestley: We finally made it, but you have the B-list presenter today. I'm really sorry about that, but Vince is on vacation.
Kline: It's funny. For our audience, I should probably point out that presenter means host. [laughs]
Priestley: Host, sorry.
Kline: Normally Vince is the host, and Sarah is sitting as the host today.
Priestley: Fantastic, thank you for the clarification that we are not on a chat show. I'll dive straight into what are topic for today is: the supposed death of the retail industry. Retail spending as a whole, according to the Census Bureau, is up 5% year over year, and up 17% in the last five years. But the conventional wisdom as you described it in one of your recent articles, is that the retail industry is kind of dead, it's dying. And there's a lot of enthusiasm for that, and I'll play devil's advocate here for just a minute and go into that. On the surface, there's a lot of evidence that backs up that point. In the past year or two, we've had bankruptcies from Payless, The Limited, Wet Seal, Gander Mountain, Sports Authority, and recently we're seeing a lot of news about store closures. Macy's (M -0.68%) is closing 100 stores, J. C. Penney (JCPN.Q) over 100, Sears (SHLDQ) -- 78 Kmarts, 26 Sears locations, and they've even admitted substantial doubt in their ability to keep the doors open.
Kline: It's one of those things where what you see isn't what's actually happening. You walk around the mall -- we were talking about this upstairs -- the mall near me, the lower-grade mall, about a third of it has become the fake edifices where they put a vending machine and a "Coming Soon" sign, and there's nothing there, because a lot of stores have gone out. RadioShack is one you didn't mention, they've closed 1,000 or 1,100 on their way to complete oblivion, their second bankruptcy. You look and go, "Oh my god, mall retailers are closing." My Macy's closed, the Macy's I could walk to from my house literally closed. And it would seem like that makes sense. The narrative is, the internet is killing physical retailers.
Priestley: Yeah. The Amazon effect, as people call it.
Kline: And I believed it as well. And then I went to the Shoptalk conference. I mention this because this research came from a gentleman named Kasey Lobaugh from Deloitte. What he pointed out, and he only showed one quarter's worth of data, and the people who track retail data, National Retail Federation and others, they don't break out internet versus physical retailer sales. So, this is a bit elusive. But, what he said is, during the fourth quarter, the holiday season, the overall dollar growth of physical and online was about the same, it was $12 billion each. In terms of physical retail, which is much bigger, that turned a 2%-3% gain. On the online side, it was 13%-15% gain. But, the reality is, what we're seeing is, failing stores are closing, and there are plenty of chains that are taking their places. If you look in the discount space, Dollar General is opening 1,000 stores this year, and they opened 1,000 last year. Even chains that have a perception of struggling, like Target (TGT 11.62%), are opening and adding. Target is going into markets that Wal-Mart (WMT 1.13%) had decided to not go after, which is cities, and they're putting in 20,000-30,000-square-foot stores, about 20% the size of their regular stores. You're seeing fragmentation and a shift in retail. Today, there was a story that Warby Parker, they eyeglasses people who both of us would probably do well to visit, is opening more retail stores. So, you're absolutely seeing the Amazon effect killing certain retailers, but it's also creating opportunity for other retailers.
Priestley: Absolutely. I think the retailers that are being rewarded are the ones that are actually listening to their customer and understanding what their customers want. As you quite rightly pointed out, retail as a whole is growing. E-commerce is growing at a faster rate, but e-commerce as a whole is growing. I think Moody's estimates the discount environment to grow 7% this year. Obviously, people are still going to the stores. It's not like we're going to be telling our grandchildren what a shop was like and staying inside all the time. So, why do you really think that some of these stores have it right, and what do you think investors should be listening out for?
Kline: If you're Dollar General, you're competing on price, you're basically going in and saying, "Amazon might be as cheap or even cheaper, but I have it now." They have hit the sweet spot when it comes to pricing. But a lot of the chains that are working are ones that offer an experience. Best Buy has turned the corner, and part of the reason Best Buy succeeds when we just lost hhgregg is, when you walked into hhgregg, it was very 1980s retail experience. There were refrigerators over there, there were stereos over here, there were computers. There was nothing joyous or interactive about the store. When you walk into a Best Buy now, you can go play with a Nintendo Switch, you can go sit in a chair and try out different audio systems. There's stores within a store, which is a concept J.C. Penney is using, too. We've talked, I have a background in retail, I ran a giant toy store for two years. If you give people a reason to come in, it could be as simple as there's a coffee shop in my book store and people want coffee, if they have to walk by all your merchandise on the way to the coffee or on the way to play the Nintendo Switch or on the way to get a haircut at JCPenney or take their picture at Sears or wherever it happens to be, that's a chance to capture them as a customer. So, retailers have to think smarter. I think that's something that Macy's missed out on, and Sears really missed out on. You go to Sears now and they're struggling, and it's still hard to find the merchandise you want. They have not made them. And I buy clothes at Sears sometimes, they have not made the shopping experience easy. The alternative is, I can go to Amazon and say, "I want pants, I want this size and color," and in two days they show up, and if they don't fit, I'm supposed to return them but I don't, so Amazon just gets another pair of pants sales from me.
Priestley: Absolutely. I was listening to a webinar that was done by the same guy from Deloitte, and one of the things he was mentioning was, the department store construct actually doesn't work well for a holistic, natural kind of shopping experience. The example that he gave, which I'm going to paraphrase, is that when you go to the luggage section, you may want to buy luggage for your vacation, and what would be great to have with this is women's summer dresses and bikinis and flip flops and all those kinds of things. But because they're territorial about the space allocation, they're incapable of being flexible to provide customers want.
Kline: But you are seeing more of that. We talked about Target before. The new Target setup that they're starting to roll out, I think it's about a third of their stores this year, is going to have one entrance for Grab & Go. So, you walk in, you want a snack, you want a drink, maybe they've found that toilet paper is something that people just want to buy and leave, they need toilet paper -- that's a terrible example. The second entrance is going to be clothing and seasonal items and things people take more time to buy. So, as a retailer, you have to align your store to your market. It's very simple. If I walk into a liquor store, they've figured out a long time ago to put the gin next to the tonic, and that the olives should probably be somewhere close by. But when you walk into a Macy's, shoes and socks are not necessarily in the same place, or pants and belts, or to take it, as you did, to another level, where you go to these more esoteric connections. You need to see more dynamically changing stores, where they're seasonally really making moves to captivate customers. And you have to just make shopping fun.
Priestley: Yeah, absolutely. I think another thing is, a lot of these retailers sell things that are so easily commoditized online. And like you said, if they don't have that experience element to the shopping experience, they're going to lose out. If you take Home Depot, for example, their stock is up 10% this year, which is completely different from the rest of the retail environment. They offer something that you really can't replicate online. They have experts who are going to give DIY-ers advice. You can't really sell lumber or deliver lumber and paving slabs that easily. And I admit that that's very difficult to transfer to clothes and things like that, but it's a similar principle. You're getting a lot more of a value proposition.
Kline:There's also an immediacy. Obviously, if you're going to buy drywall at Home Depot, you're either going to pay them a fortune to deliver it. It doesn't really matter if you come into the store how you get it. But if your sink is broken and you need a plumbing piece, you don't want to wait for two days. And Amazon has some methods of dealing with that. They have a patent application on a truck that drives around that can 3D print parts like that. But until things like that exist, a lot of the demand at a store like Home Depot is, "It's Saturday and I'm free and I'm going to build a fire pit outside." Or, "Oh my God, my toilet doesn't flush anymore, I have to get the pieces to do that." But other retailers have to figure out how to make that happen. Do you buy clothes online?
Priestley: No, I don't. I don't buy clothes online because I would like to try clothes on and feel them and everything else before. And what my husband believes is going to happen is that you almost have a showroom where you go and try the clothes on and then order them and they are delivered at home. I don't know if I buy into that, because I very much like to feel the weight of what I've bought when I've bought it. But, that's another possibility.
Kline: I do a mix. I will go to a Kohl's or Macy's and I'll buy a shirt. And if I like the shirt, I will then by 10 more of the shirt online. I agree, especially with women's sizing, a small doesn't mean things the way, men's sizes are more exact in terms of inches and length. So, it can be a challenge. But I think the tools are eventually going to make it so you can virtually try things on.
Priestley: That's true. I wonder how much they're going to catch on. I know there's a lot of tech disruption people are talking about. [Virtual reality], you can look at a screen and it will try on the clothes for you without you having to actually go into a changing room. I don't know how much they're going to catch on, and if that's really where the tech disruption is happening. I think the tech disruption is happening much more in terms of the granularity of information that you have over your consumers' social media campaigns, all those things that probably weren't available when these big stores were established. But, I really think, as you said, they could take lessons from these nimble start-up companies that have entered the market with zero barriers and are really cashing in on where the retailers are failing.
Kline: And I think one of the things you're seeing with Wal-Mart, which is another retailer that's had its struggles but is quietly growing and adding stores, is the true integration of "buy online, return in store." I buy from Amazon almost every day. And I joked earlier, but if I buy a shirt and it doesn't fit, the odds of me going through the trouble of returning it are very, very low. If all I had to do was walk to the mall and drop it off at the Amazon kiosk, that would be a lot easier. For now, Target, Wal-Mart, even Costco is playing with this a little bit, have that advantage that you can buy something digitally, and when it doesn't work out, it's a lot easier to return it than having to figure out how to get UPS to pick up at your house.
Priestley: And that's really a small example of a bigger problem with this. Omnichannel, for a lot of the traditional retailer CEOs, really means you have your store and you have your online presence, whereas those things, those two things are basically integrated, they're essentially the same thing. We are online all the time, I can be in a Target store and checking on Amazon to do a price comparison. It's those kinds of things that I think they need to stop looking at it like, "5% of revenue is from mobile and 95% is from in store, so all my focus needs to go on the in store," and actually focus on the two things as an integrated experience.
Kline: Marc Lore from Wal-Mart, who runs their digital operation, talked about this. I think more chains need to bring in digital-first people and empower then.
Priestley: Absolutely, he came from Jet.com through the acquisition.
Kline: And he created Quidsi, which is Diapers.com. He's been a serial success-failure. He's had companies that weren't making any money that scared Amazon. First Amazon brought Quidsi, and then Walmart bought Jet, which was a company losing money on $1 billion in sales. He's a really interesting case. When you inject him into this old line way of thinking at Walmart, he goes, "Wait a minute, we are not going to compete with Amazon by selling a Prime knockoff. It isn't going to work. So let's just give it away." You have to be willing -- this is a very tough thing for a retail CEO to deal with -- to have some bad quarters, because you're going to cut into your margins, you're going to do a lot of negatives. But if you can capture a customer and have a good experience, I bought some things online at Kohl's, and they shower you with discounts and all sorts of other ways to get you back, it was a pleasant experience and I would absolutely buy from them again. And I think that's what more of your Macy's and your other chains -- it might be too late for Sears, I'm not sure Shop Your Way, which they talk about being the future of the company, has any customers. But you really need to break everything and figure out, "I have this asset, these physical stores, how do I keep my customers a customer whether they're coming into that store or not?"
Priestley: And on that point about the physical stores and the size, I'm interested to get your opinion on whether all of this space is still going to be saved, because I have an interesting statistic. The U.S. has six times more square feet per capita retail space than the U.K. And obviously, so that is the availability of space. But, that's a huge amount of retail space. Can all of this be used?
Kline: No. It's too much. We talked a lot about this -- there's jokes on The Simpsons about the sad mall, but most communities have the sad mall, which maybe has the C-level Macy's or JCPenney's as the anchor, and it's the only mall that has some local stores, and maybe one of those places that sells $49 suits. I think you're going to start to see -- and, actually, we talked about this a little bit upstairs -- the new mall is going to push out the old mall. You're going to see closures. There's a demand for housing, so you're going to see a lot of conversions. We have too much retail space. There were a lot of articles this week about how difficult it's going to be to fill the 300-something hhgregg stores. There's only so many trampoline places that can go into a town, or movie theaters. And yeah, some malls can be anchored by grocery stores. But, no, we have too much space, and there's going to be an absolute pullback in that area.
Priestley: The concluding thoughts on that basis, then, is that some are going to lose, but generally, if you can target your customer, if you can meet your customer where they're at, you can still make the most of the space that you have.
Kline: Yeah. I think you have to do what JCPenney is doing and look at your stores, and maybe get rid of some of them. Or, change locations. Apple near where my mom lives, in Salem, Massachusetts, was in the mall. They've recently moved to an outdoor plaza, because they found that if you're going to get your iMac repaired, it's a giant pain to walk a 27 inch computer through the mall, drop it off, then come back and pick it up, whereas if they could locate in this lifestyle plaza, you can park right in front of the store, you can walk in, and it's a much easier shopping experience. So, I think stores and retailers need to examine on a store-by-store, location-by-location basis, does this location make sense? Can I make better use of the space? Can I bring in vendors or partners? Are there services? If I'm a JCPenney, should I double down on salons, should I put in a massage studio, should there be yoga at Barnes & Noble (NYSE: BKS)? Who knows what else. I've joked for years that Barnes & Noble should put in music lessons because it would be a very logical tie-in to what they do, and they already sell all the books. You should be looking at diversification and capturing people and going beyond shopping. There's very little that you need that it isn't easier to get from Amazon. So, if the experience isn't enjoyable, and there isn't a nice cup of coffee or a frozen yogurt or something that's part of the experience, then you aren't going to leave your house.
Priestley: You said double down, that was the phrase you used on the concept, and I think that's exactly right. The problem with department stores now is they're trying to be everything to everybody, and have not really been successful anywhere. I think these companies need to know who their audience is, who their consumer is, and really facilitate what they want. Barnes & Noble yoga classes sounds ridiculous, but if Barnes & Noble's cafe has a lot of stay-at-home mothers and young students that might be interested in doing things like that, then it's a great idea.
Kline: If you're Barnes & Noble, you're locked into leases, very long-term leases, in a lot of cases. And you used to stock music, DVDs.
Priestley: Those things used to exist. [laughs]
Kline: You don't need those anymore. And while they've brought in games and some other sort of incidental retail, most Barnes & Nobles locations have big, empty spaces. So, what do you do with the space? You could make it a day care, you could make it a yoga studio, you could make it music -- you know, privacy places, whatever it is, figure out how to monetize that. Retailers use a formula where they look at, how many dollars is this square foot producing? If it's just picnic tables where people can read your magazines for free, it's not producing any dollars. There's a lot of low-impact ways -- bring in an outside vendor. What's compatible to book sales? Maybe women's shoes are up. Super logical. You find there's a correlation, maybe it's pet supplies. I don't know what the answer is. But, do those studies, and go to those vendors. If you go to Wal-Mart in certain markets, there's eyeglass places that are not Wal-Mart, there's Music and Arts, which is a chain of music retailers that specializes is mostly in elementary school kids and lessons. Find the things your customers want and bring them in. Even if it's just a breakeven, they're going to shop at you more. Costco worries about frequency of visits. The reason they essentially give away gas is because you're going to come to Costco more often, you're going to be more tied to them, you're going to renew your membership, maybe you'll buy more stuff. Every store needs to think that way.
Priestley: So, final thought, if I'm a Macy's or a Sears investor, what would you advise me to listen out to, and in the earnings call, what would you want to see from management?
Kline: If you're a Sears investor, don't believe anything they're saying. It's a bit of a shell game. Vince and I have talked about this at least four or five times. If you have $2 billion in assets and $8 billion in debt, you might be able to use your assets for a certain amount of time to forestall your debt. But if you haven't fundamentally changed your business, which they have not, then you're in real trouble. Macy's is a different story. Macy's is a profitable company that's not as profitable, that's struggling. I would look at, are there really new ideas? Are they doing things differently? Are they making bold changes? I would like to see Macy's testing 10 concepts that seven of them sound crazy to see what they are. Maybe they're renting out birthday party clowns in one store, and they are putting an upscale cafes, which I think some Macy's actually have. But, find different things, try different things. Also realize that if you're Macy's, the negativity is partially because you are a publicly traded company, which is expected to grow, grow, grow. As a private company, which could happen, there has been some interest in buying them, they're a stable business that just needs to pivot. They're not a failing business the way Sears is.
Priestley: OK. Well, that's great, thank you very much. Dan, do you have any more final thoughts?
Kline: I'm just happy to have done this. And you got through it! Sarah was very nervous as we headed into this.
Priestley: Well, I have big shoes to fill with Vince usually hosting this.
Kline: Lots of jokes I could make about Vince's shoes there. But we look forward to having him back.
Priestley: Listeners, that does it for this episode of Industry Focus. If you have any questions or you just want to reach out and say, "Hello," shoot us an email at [email protected], or tweet us @MFIndustryFocus. If you're looking for more of our content, subscribe on iTunes or check out the Fool's family of shows at fool.com/podcasts. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. For Dan Kline, I'm Sarah Priestley, thanks for listening and Fool on!