Thanks to rising consumer confidence and low unemployment, the 2017 holiday season proved to be generous to brick-and-mortar retailers. In this episode of Industry Focus: Consumer Goods, Vincent Shen and Adam Levine-Weinberg go over early results from some of the biggest players in retail.

Find out what the reports out of Macy's (M 2.80%), Kohl's (KSS 0.87%), Target (TGT 2.19%) and JCPenney (JCPN.Q) have to say about the companies' short-term and long-term horizons; why we can probably expect to see bankruptcy filings from Sears (SHLDQ) and Bon-Ton (NASDAQ: BONT) before too long; and what it means now that Wal-Mart (WMT 0.63%) is closing about 10% of its Sam's Club locations.

A full transcript follows the video.

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This video was recorded on Jan. 16, 2018.

Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Tuesday, Jan. 16 -- I'm your host, Vincent Shen. Fools, I hope you enjoyed the holiday. To start the new week, I'm enlisting the help of senior Fool.com contributor, Adam Levine-Weinberg, who's calling into the Fool HQ studio via Skype. Hey, Adam! Thanks for being here!

Adam Levine-Weinberg: Thanks for having me on the show again!

Shen: Yeah. I wanted to bring you onto Industry Focus today because back in late November, we discussed the outlook for department stores for the 2017 holiday season, and across the industry, we talked about how it would be really important for retailers to keep up the positive momentum they'd built up on the Black Friday weekend. Well, at this point in the new year, quite a few major retailers and some of the big box stores have reported preliminary results from the end of the year. The tone of the industry seems more upbeat than it has been in quite some time. Let's go, top to bottom, from best to worst performers for the holiday period. Which companies ended up leading the pack?

Levine-Weinberg: What we saw over the holiday season was the off-mall retailers did the best among brick-and-mortar retail. Kohl's actually had the very best results of the companies that have reported so far. It said the comp sales were up 6.9% during the holiday season, and that's its best result in over a decade. If you look on a full-year basis, for the past five years now, Kohl's has basically been flat. Comp sales basically the same as they were all the way back in 2011. So this is really quite a dramatic change in the trend at Kohl's and really quite impressive, and it sent the stock flying higher, not surprisingly.

Shen: The big thing I saw from their press release to note is, they call it strong traffic, which is always something we're looking for, especially with these retailers with a physical store presence like this. They also called out the online channel, with growth for that channel accelerating during the two-month holiday period. Definitely interesting to see.

Levine-Weinberg: Yeah, it's definitely good to see a company that's generating very strong online growth, but also seeing growth in its stores. Kohl's is definitely benefiting here from the fact that its stores are in more convenient locations, generally speaking, in strip malls or stand-alone locations, where people are dropping by frequently, whereas a lot of the other department stores that they're competing against are very much tied to malls. As you know, mall traffic has been declining for years and years, and that trend doesn't seem likely to end anytime soon.

We also have Target. Similar in terms of the locations to Kohl's, so not surprisingly, it also did well over the holiday season, with comp sales up 3.4%. That allowed Target to raise its guidance for the year. That's actually the third time now in the past year that Target has raised its guidance -- 2017 went from, at the outset, it seemed like a very downbeat year for Target, to being actually fairly good in light of the competitive pressure that it's seen from some of its rivals.

Shen: Yeah. It's very encouraging with the turnaround plan that they've mentioned, that management has pointed to as their roadmap. Again, similar to Kohl's, they cited strong traffic, so there's that first good sign. Then, also, strong results in the digital sales. Their digital channel enjoyed growth of 25% in full-year 2017. We talked about trends recently for retail in 2018. Omnichannel is leaving its footprints here as well. Stores fulfilled 70% of Target's digital sales volume in November and December. That's something that we'll see with some of the other companies we'll talk about today as well.

Levine-Weinberg: The one thing I would mention about Target is, compared to the department stores, it gets much, much lower percentage of its revenue online, even now. It's been posting very good growth but from such a small base. I think online is still about 3% to 4% of its revenue, whereas with some of the other companies we'll talk about like Macy's and Nordstrom (JWN 2.33%), that's like 20% to 25%.

Shen: Yeah, about one quarter, so definitely a long way for them to go. Starting from that smaller scale is good, but seeing that growth, you definitely want that. Wal-Mart  has enjoyed really strong growth rates in that space as well. They've made investments there. Both companies definitely racing in that space. You mentioned the off-mall retailers leading the pack. The middle pack, the traditional department stores that you and I cover all the time, these are companies that we've looked at for years now, and they also had surprisingly strong numbers, too. We'll go over some of those.

Levine-Weinberg: JCPenney was definitely the best among the traditional mall-based retailers. Up until a couple of years ago, it was showing a pretty strong sales comeback. That trend changed over the past year or two. Most of 2017 was pretty bad for JCPenney. But actually, they had 3.4% comp sales growth during the holiday season. That's definitely encouraging, showing that they might be back onto a better trend, which could help them looking into 2018.

Going a little further down the list, Macy's and Nordstrom both posted comp sales gains of a little over 1%. That's definitely solid, especially for Macy's, which had posted a comp sales decline for 11 straight quarters coming into the holiday season in 2017. So it's pretty encouraging to see comp sales growth, even if it's a still a pretty low number at these companies, because, especially Macy's, has really struggled to get traffic in the doors, mainly because of that mall focus that we talked about a little bit earlier.

Shen: Both of these companies you just mentioned, JCPenney and Macy's, they're trying to highlight their digital growth, the things that they're doing on that side. JCPenney, they mentioned that 100% of their store locations assisted in e-commerce fulfillment. How much that is in terms of each store and the ultimate impact, it's hard to say. But obviously, that's something that the management team seemed focused on. For Macy's, we point to digital growth, too, how it's a bigger base for them. On the flip side, the company is still reducing its store fleet. I think they closed 125 locations since 2015, so that's about 15% of their footprint. Obviously, that's one company that you and I have spoken about several times, Adam, where they're still trying to right-size their physical footprint and monetize their real estate assets where it makes the most sense to do so. One more company here that I want to cover is Nordstrom. How did they do?

Levine-Weinberg: Nordstrom had about a 1% comp sales increase in its full line stores, and a 2.9% increase in its off-price business, which is Nordstrom Rack. Those are definitely solid numbers, especially in the full line. To be honest, I would like to see the off-price number be even higher, because right now, Nordstrom has been rapidly expanding its online, off-price business. Up until a few years ago, there was no Nordstromrack.com e-commerce business. It's definitely a high-growth business in terms of revenue, but it's actually not profitable. So what you've been seeing recently is actually top sales declines in the Nordstrom Rack physical stores, whereas other off-price retailers have been posting pretty good growth, whereas all the growth has been in this unprofitable e-commerce business. So that's not really helpful in terms of overall company profitability. I'm hoping to see further acceleration in that trend next year. You'd like to see more mid-single digit comp sales growth in Nordstrom Rack and Nordstrom's other off-price business.

Shen: And correct me if I'm wrong, but Nordstrom Rack is the sole part of the business where they've still been trying to expand their footprint, add new stores each year. With the effort, the investments they're putting into that, you definitely want to see strong numbers coming out of there, so it's understandable, in terms of those expectations. 

Closing out now, some of the companies that did not do as well. Some smaller ones, one of them is not a surprise, can you run through those?

Levine-Weinberg: Yeah. It was definitely interesting that while you saw really good sales numbers for most of the department stores, the ones that have been perennially the laggards continued to be laggards during the holiday season. First of all, you had Sears Holdings, which has just been a complete disaster for many years now. They own both Sears and Kmart chains. They've been closing stores at a pretty remarkable pace. During 2017, they will have closed about a quarter of their entire store base. Even with all those stores closing, they're still seeing double-digit sales declines within their remaining stores. They are on track for a 16% to 17% comp sales decrease during the holiday season, which is really just phenomenally bad. They tried to go back to the well with some of the nostalgia plays. They brought back the Sears Wishbook catalog from decades ago. They brought back Kmart Blue Light specials. They went with the strategy of putting the entire store on sale well before Black Friday to try to get traffic in in advance, and none of it worked. It's just not surprising. Sears is basically dead. The only reason why they're still in business, to be perfectly blunt, is they've had billions and billions of dollars of real estate and valuable brands, which they've been selling off at a steady pace, year after year, for about five years. And that's brought in enough money to keep the company afloat, despite free cash flow that's been negative to the tune of $1.5 to $2 billion every year. At some point in the next couple of years, they're going to run out of things to sell to keep the business afloat, and then it's going to collapse.

The other company that I wanted to talk about today was Bon-Ton. Bon-Ton is a smaller department store chain, but it's still pretty significant. It has about $2.5 billion of annual revenue. They had been posting very, very poor comp sales results, mid to high single digit declines during the first three quarters of 2017. But they said on their conference call back in mid-November that the first two or three weeks of the fourth quarter had been quite good, with comp sales up in the high single digits. By the end of November, they reported that comp sales were actually up about 3% for the full month. And then, when they reported their holiday sales about a week ago, they said, actually, for the full holiday season, November and December combined, comp sales were down about 3% year over year. So you just saw a huge change in trend again, or a return to the previous trend, in December with serious significant comp sales declines. 

This is a company that has just a few million dollars of cash in the bank trying to support a $2.5 billion business. It doesn't generate free cash flow, it's losing money every year, doesn't have the kind of properties that Sears has in order to bring in cash. As a result, there have been reports out in the last few days that they're likely to file for bankruptcy in the next couple of weeks or so. And at this point, it's really a question of whether they manage to restructure somehow, or the company gets broken up or they liquidate entirely.

Shen: Yeah. We've covered a range here of some of the names that we talked about on that previous show in November, following up, giving a progress report. Overall, a lot of the retail industry group, some of the various research firms, had expected about 3.5% to 4% increase in consumer spending, a strong holiday. We're seeing that come through for most of these companies. Let's talk a little bit about, on the earnings side and profitability side, on the bottom line. I've seen a lot of guidance changes, guidance updates, not only for 2017, for the full year -- a lot of these quarters are ending at the end of this month -- but also for 2018 as well, a little bit more optimism in the results from these management teams. What are you seeing there?

Levine-Weinberg: Kohl's, not surprisingly, given that 6.9% comp sales increase, increased their full-year guidance by about 9%. That's pretty remarkable, in the last month of the year, to raise your full year guidance by that much. That doesn't even include the impact of tax reform, which will probably give another 1% or 2% of growth in fiscal 2017. Most of the benefit of tax reform will actually come in fiscal 2018, when it will probably provide an additional 20% boost to earnings per share just because Kohl's, and many of these other retailers we're talking about today, is a full taxpayer under the old system. So they were paying about 37% to 38% a year. That's going to go down to maybe 23%. That's a really remarkable change in tax rate and really big savings. Target, also very strong comp sales results. Target raised its guidance by about 4% for the full year. That does include a small benefit from tax reform. 

Looking at Macy's and Nordstrom, they also updated their guidance, and they were a little bit more conservative. They said guidance was going to be at the high end of the previously provided ranges in both cases. It's not surprising that they're not beating those guidances, just because they didn't have the same level of comp sales growth. As you recall, they were both up about 1%. Then, finally, you have JCPenney, which had 3.4% comp sales gain but did not update its earnings guidance. We'll have to wait and see there. It's possible that the original guidance was just pretty aggressive. It's also possible that JCPenney doesn't want to update the guidance until they're sure. It's also possible that they had to do more discounting to drive that sales growth. We'll just have to wait and see how they got that kind of sales growth.

Shen: Yeah, we'll definitely have a little bit more color to share. A lot of these companies will be reporting in the next month or two. Next up, we'll talk a little bit about what lies ahead for these companies more specifically to close out discussion, and then we'll talk about some recent news from the king of retail, Wal-Mart. 

Adam, last time, we pointed out things to watch for the rest of 2017. Now, we're still in the first few weeks of the new year. What are you going to be following for 2018 now, and maybe even looking out further than that?

Levine-Weinberg: Even with these really strong holiday sales results, department stores and big-box discounters like Target still face some pretty significant challenges, mainly from the rise of e-commerce. A lot of people, just looking at the industry from a very high-level perspective, say, "These companies need to focus on their e-commerce and omnichannel businesses, drive more business online." And that might look fine for sales, but generally speaking, the in-store businesses have very high fixed costs, whereas e-commerce has very high variable costs. The result is, if you are posting 2% growth, but it's actually a 2% to 3% decline in your comp store sales in store offset by 30% growth online, you're actually seeing your costs rise much faster than your revenue. And indeed, you've seen very severe margin pressure on all of these retailers in recent years. These companies need to be able to drive more traffic to their physical stores while also driving the e-commerce growth to add to the top line. That's why it's very encouraging to see what Kohl's has done in this past quarter, and also to some extent, Target. We definitely like to see that continue going into 2018. It does help for all of these retailers, even looking at the mall-based stores, that they're going to face very easy year-over-year comparisons for most of the coming year, just because the results were so bad for the first three quarters of 2017. 

That said, I would also like to see some of the weaker retailers disappear, to be perfectly blunt, because they're taking up business. Even as they're posting big comp sales declines, they're still taking a significant chunk of this in-store business and dragging down other healthier retailers that really ought to be able to survive in the long run. So I think we are going to see that shake-out now in the next year or two, because those weaker retailers like Bon-Ton and Sears that have been flailing around for years and not making any progress toward a sustainable turnaround have reached the end of the line now. And without some miracle in the next few months or years, they're probably going to be gone by 2020 at the very latest. And I think that'll be good. Particularly if you look at Sears, JCPenney has really positioned itself to pick up a lot of that business by moving into appliances and home services. I think Macy's, JCPenney, Kohl's, they're all in the position to pick up some business if Bon-Ton were to go under. So I would definitely say that the consolidation of the sector, just by some of the weaker names dropping out, could provide an additional impetus to improve the profit trajectory at the remaining department stores in 2018 and going forward.

Shen: And that would continue a trend that we've already seen. We've seen record numbers of bankruptcies and store closures in 2017. If we step back a little bit and think about some of the macroeconomic indicators like low unemployment, we have rising consumer confidence, which happened to be at its highest level in the past decade right around the holiday season, and it's been a really good stock market. That's definitely helped to explain the big spending from the holiday period that we talked about and the results from these companies. At the same time, I'm glad you brought up the potential closure for these weaker retailers. There were 7,000 store closures in 2017. It helps when the survivors can pick up additional traffic and market share. After record years for those bankruptcies and closings, the U.S. market overall, keep in mind, still has way more retail square footage per person than other parts of the world -- as much as five times more than countries in Europe, for example. There's always that bigger picture context. With these closures, we're still right-sizing that footprint, these companies are still figuring out what the balance will be between their physical and digital channels. I think consumers and investors should definitely expect to see that trend continue in 2018 and beyond as they tweak the way they use their real estate and what that looks like going forward. 

That brings us to the last topic for this episode, it's a related story that has made a lot of headlines in the past week. On January 11th, Wal-Mart made multiple announcements regarding improved pay and benefits to Wal-Mart employees, a one-time bonus, and also the potential effects of the new tax legislation. But I think management was hoping that the good news would offset the announcement that they are closing 63 Sam's Club locations in the country. That's about 10% of its U.S. store base. Can you give us some of the details here, Adam?

Levine-Weinberg: Sam's Club has always been the smaller part of that Wal-Mart business -- not really as big of a focus for the company as the traditional Wal-Mart business, or even Walmart's international business. It's just struggled along. They never really found their identity. Initially, they definitely went for the lower-income demographic that was closer to the traditional Wal-Mart customer, rather than the higher-income demographic that Costco (COST 0.85%) caters to. The problem is, those people obviously haven't been doing nearly as well with the current economic climate, which has been great for high earners and not as great for low earners. So you've seen very sluggish results, whereas Costco has been growing very quickly in the last decade, and honestly, in the last three decades. Wal-Mart more recently changed the Sam's Club strategy to try to pick up more of the shoppers from Costco, putting more organic products and upscale things. It just doesn't have that kind of brand power that Costco does, and its association with Wal-Mart probably doesn't help, in terms of trying to get consumers who have $100,000-plus household incomes. 

Anyway, whatever the cause, Wal-Mart decided that there's just too many Sam's Club locations and some of them aren't profitable. You've had basically a mix of those two different things going on here. In some metro areas, they built more clubs than there was demand for. Sam's Club is just thinning out the number of warehouse clubs that they operate. You're seeing this in Chicago. There's six different warehouse clubs in the Chicago suburbs that are all going to be closing in the coming weeks. That's about a third of what Sam's Club operated in that area. In most cases, Sam's Club customers will still have a location that's relatively close by that they can continue to go to. Although, I definitely think that Costco will pick up some business from people who now find that Costco is more convenient to them than Sam's Club. 

But what you've also seen is, there's entire markets where Sam's Club seems to have decided it can't compete. One of the most interesting ones is Seattle. They're closing all of their Seattle area warehouses, that's three of them. That's Costco's home market, so it's not surprising that they're in the worst position there. Costco now basically has a monopoly on that warehouse club model in Seattle. Also, Alaska, they decided to exit. They had three stores there, two in Anchorage and one in Fairbanks. Those are all going to be closing. Again, that'll give Costco some room to expand. Then, in the Northeast, just to start out, Sam's Club was a lot smaller than Costco, and now it's pulling back even more. Pulling out of Syracuse and Rochester, New York, Upstate New York. It's closing its only location in Massachusetts, two of its three Connecticut warehouses, among others in that Northeast corridor area, so really thinning out its position there. Sam's Club warehouses traditionally haven't been able to generate the same level of sales volume as Costco warehouses, so having them in these far-flung locations with only a few here and there wasn't really working from logistics perspective, given that the margins in that warehouse business are very tight to begin with, even more so than in Wal-Mart's discount store supermarket business.

Shen: Not surprisingly, if you read between the lines, it seems like some of these stores were cannibalizing each other. I read a comment somewhere that said the company realized that the population growth in some of these weaker markets that they had forecasted just didn't live up to those expectations, it couldn't sustain the supply of stores they had there. We've spoken previously on the Industry Focus about greater competition with consumers' grocery budgets. If you look at Sam's Club's main rival, you mentioned Costco, for November and December, they reported 8% and 9% comparable sales growth in those months respectively. They, too, have turned their attention to e-commerce. Over 30% e-commerce growth for the company in those periods, too.

I think that number is significant, because it also adds some context to the decision. One the one hand, you have these store closures. On the other hand, Wal-Mart mentioned they're converting 12 of these club locations into e-commerce fulfillment centers. I think the recent holiday season may have been encouraging for a lot of traditional retailers, but bubbling beneath that is still this shift with consumer spending to online digital channels, and a lot of these investments and turnaround plans and long-term strategies for companies in this industry prioritize that shift. Wrapping up here, any final comments from you, Adam, before we roll off?

Levine-Weinberg: I would just say that it'll be really interesting to watch Costco's sales results over the next few months, just to see if they see a noticeable bump from the Sam's Club closures. Particularly because Costco has been reporting really strong comp sales results, as you mentioned, but it's had pretty easy year-over-year comparisons, because it wasn't doing that well in 2016 and early 2017. So now that the comparisons are getting harder, it'll definitely help Costco to now have this Sam's Club traffic that it can pick up. The other thing that I would look for is to see whether Costco decides to pick up any of these Sam's Club locations that are closing, if it sees them as suitable sites for new Costco warehouses, or if they announce new sites elsewhere in those metro areas to try to gain even more market share from these Sam's Club closures.

Shen: Thanks a lot, Adam, for joining us today!

Levine-Weinberg: Thanks for having me on!

Shen: Sure. Thanks, Fools, for listening! 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 during the program. Fool on!