After spending several years in the doghouse, department stores have come back into favor among investors during the past year. Shares of better-performing department store operators like Kohl's (NYSE:KSS), Nordstrom (NYSE:JWN), and Macy's (NYSE:M) have achieved huge gains since last fall.
However, all three stocks have pulled back over the past week or so, following a disappointing August retail sales report from the U.S. Census Bureau. Yet investors may be worrying too much about a single month's numbers in a "noisy" data set. If shares of Kohl's, Nordstrom, and Macy's continue to fall, it could be a nice buying opportunity for long-term investors.
The raw data
The August advance monthly retail sales report showed that U.S. retail sales inched up 0.1% last month, compared with July. This was weaker than the 0.3% to 0.4% increase that economists had expected. Excluding gasoline and auto sales -- two volatile categories -- retail sales rose 0.2%.
The 0.1% headline month-over-month increase marked a significant slowdown compared with the upwardly revised 0.7% increase reported for July.
Furthermore, while overall retail sales growth remained strong on a year-over-year basis at around 6%, sales at department stores decreased 1% from July and fell 0.7% year over year. For comparison, during the May to July period -- which roughly lined up with retailers' second fiscal quarter -- department store sales rose 0.9% over the prior three-month period and 0.6% year over year.
Not all department stores are thriving
While Kohl's, Macy's, and Nordstrom posted strong results in the first half of fiscal 2018, not every department store chain has returned to health. In fact, regional department store operator Bon-Ton liquidated all of its 260 stores earlier this year.
Sears Holdings (NASDAQOTH:SHLDQ) isn't doing much better. It continues to post comp sales declines each quarter, despite closing stores at a phenomenal rate. In fact, Sears Holdings has either closed or is in the process of closing roughly a third of the 547 full-line Sears stores that were operating as of early February.
J.C. Penney is struggling as well, albeit not to the same extent. Comp sales have been roughly flat year to date. Lord & Taylor has also faced sales pressure in recent years -- as a result, it plans to close about a fifth of its stores by early 2019.
The upshot is that sales tallies for the U.S. department store industry as a whole may not be very meaningful. In 2017, Bon-Ton produced about $2.5 billion of revenue, while Sears (excluding the Kmart discount chain) booked $7.8 billion of merchandise sales. The disappearance of the former and sharp sales declines at the latter -- as well as smaller declines at the likes of J.C. Penney and Lord & Taylor -- are likely creating significant distortions in the Census Bureau's data, given the relatively small size of the total department store sector today.
There's still upside in department store stocks
Looking forward, sales growth at the likes of Kohl's, Macy's, and Nordstrom will continue to be noticeably better than the overall trend for department stores. Indeed, these three companies are well positioned to capitalize on competitors' store closures in the second half of 2018 and 2019.
To the extent that the sales declines at department stores reported by the Census Bureau just reflect weaker chains' store closures, the declines are actually part of a trend that is positive for the remaining department stores. Furthermore, even if there was a slowdown in underlying sales trends last month, seasonal factors could be at play. In particular, the timing of warm and cool weather can have a meaningful impact on apparel sales.
Investors should put more weight on several quarters of sales and earnings momentum at Kohl's, Macy's, and Nordstrom than a single month of aggregated retail sales data. With shares of all three leading department store companies still trading at very reasonable valuations -- especially when calculated based on free cash flow -- there is plenty of upside if they continue to report moderate comp sales gains over the next few quarters.