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Department Store Stocks Aren’t Dead Yet

By Nicholas Rossolillo – Jun 9, 2017 at 8:26AM

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The American department store is under attack and losing ground, but that doesn’t mean they are all down-and-out.

Back in the day, department stores were anchors for shopping malls with their wide array of products including clothing, accessories, and home goods. Nowadays, internet-connected shoppers are staying home more often as they buy online and department store companies have been shutting down or closing stores in response. That doesn't mean that these mainstays of the American retail industry are dead, though.

The situation

The ourside view of a J.C. Penney store.

Image source: J.C. Penney.

In the last decade, online retailers have been growing sales by double digits, outpacing the modest 2% to 3% growth the overall retail industry has had. Department stores have been dragging that average down, though, as revenue has gone backward. Many have started offering merchandise online as well, but it hasn't yet offset falling traffic in stores.

It is important to note, though, that results in this difficult time for traditional retailers have been mixed. While some chains have been slow to adapt to changing trends, others have embraced them and are still healthy.

Metric Market Cap

Trailing-1-Year Revenue

Net Profit Margin Dividend Yield 2017 Announced Store Closures
Dillard's (DDS -1.51%) $1.63 billion $6.33 billion 2.5% 0.6% none
J.C. Penney (JCPN.Q) $1.48 billion $12.44 billion (0.9%) N/A 138
Kohl's (KSS -1.56%) $6.71 billion $18.56 billion 3.3% 5.7% none
Macy's (M -1.66%) $7.21 billion $25.34 billion 2.3% 6.4% 68
Nordstrom (JWN -0.05%) $7.04 billion $14.86 billion 2.5% 3.5% none
Sears Holdings (SHLDQ) $795.59 million $21.05 billion (7.2%) N/A 180

Chart by author. Data source: Yahoo! Finance.

Sears Holdings -- which runs both the Sears and Kmart brands -- is in especially dire straits and is at risk of going under, and J.C. Penney and Macy's have received considerable attention as they close down a large number of stores to match their footprint with sales demand. However, no major closures have been announced by the smallest player, Dillard's, nor upscale clothier Nordstrom this year, and Kohl's is taking a different approach by reducing the size of its locations rather than closing them down.

It is also noteworthy that with the exception of struggling Sears Holdings and a rebounding J.C. Penney, each chain is still profitable and pays a dividend to shareholders. While that could of course change, that's quite the contrast from the doom-and-gloom picture that has been painted.

The long and the short here is that disruption by technology is creating winners and losers. Yet as the wave of store closures continues and retailers shift to an online format, department stores have said that the need for a physical format is still important to business.

Why we still need brick-and-mortar stores

The most obvious reason for the physical store's importance is that some things need to be seen, felt, and tried on. Clothing and accessories, the main merchandise at department stores, are a prime example. Management at many stores has also maintained that keeping storefronts in key areas is part of a good advertising campaign and keeps the brand front of mind.

The inside of a Macy's store with men's attire on display.

Image source: Macy's.

Online shopping isn't always about convenience, either. In a survey conducted by Pew Research Center, 65% of American's said they shop on price first. The internet has thus become a convenient way to find the best price and conduct other product research first before making a purchase, be that online or in-store.

Department stores have been slow to adapt, but now that they are incorporating a digital strategy with their existing real estate (called "omni-channel" in the industry), that could pave the way to recovery. While many shoppers value the time savings of the digital experience, many more still get their retail therapy in-store and use the internet as a means to enhance their shopping experience rather than fully replace it.

What investors should consider

Some income investors might be tempted to buy stocks like Macy's and Kohl's because of their high-yielding dividends, but keep in mind those yields are high because the businesses are struggling and share prices have fallen. That potentially puts those dividends at risk.

The "out-of-favor" status for the department store sector of the retail industry makes it better suited for investors looking for a rebound story. Beware, though, not all will survive or stop the bleeding. Beleaguered Sears Holdings, and to a lesser extent J.C. Penney, is living proof of that. Finding the right blend of physical and digital store strategy could take some time. For those with a lower appetite for risk, Nordstrom is a compelling consideration as the company has continued to grow sales despite its peers' woes.

Long-term winners will be those able to balance investment in new business technology with discounting, all the while maintaining healthy profit margins.

Nicholas Rossolillo has no position in any stocks mentioned. The Motley Fool recommends Nordstrom. The Motley Fool has a disclosure policy.

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