On Monday, Hudson's Bay (NASDAQOTH:HBAYF) revealed that it had finally sold the Lord & Taylor flagship building in Manhattan to WeWork Property Investors, completing a deal first announced in late 2017.
This key asset sale has allowed the multinational department store group to substantially reduce its debt load. However, in addition to having too much debt, Hudson's Bay is also struggling with weak sales and poor profitability across many of its retail banners. Addressing these issues will be difficult and may require some tough decisions by management over the next year or two.
Hudson's Bay has repaired its balance sheet
WeWork Property Investors paid $725 million for a majority stake in the Lord & Taylor flagship building. The transaction valued the building at $850 million, but Hudson's Bay is keeping a minority stake worth $125 million.
Hudson's Bay also sold a roughly 50% stake in its European business and negotiated a lease modification payment during 2018, raising some additional cash. The net result is that Hudson's Bay has reduced its debt by about 1 billion Canadian dollars ($755 million) since the end of fiscal 2017.
This would put the company's debt at a little over CA$2 billion, consisting primarily of a $1.25 billion mortgage on the Saks Fifth Avenue Manhattan flagship store. Hudson's Bay has also contributed a significant proportion of its real estate to several joint ventures that have close to $3 billion of borrowings not reflected on the company's balance sheet.
The Lord & Taylor chain is still broken
While the Hudson's Bay balance sheet is in better shape now, its underlying operations are far from healthy. First, Lord & Taylor's struggles go far beyond the flagship store that closed last month. The chain has experienced steady erosion of its customer base over the past few decades and has been unable to keep up with trendier rivals like Nordstrom (NYSE:JWN).
Management acknowledged the need for restructuring last year and indicated that the company would shutter up to 10 of Lord & Taylor's 48 stores in 2019. However, it has closed only three so far. Considering that even Nordstrom has been struggling to grow its full-line sales lately, it seems clear that there are too many "premium" department stores fighting for customers. Lord & Taylor may need to close more than 10 stores to reach a sustainable footprint.
Saks Fifth Avenue will face tougher conditions
In the past year or so, Saks Fifth Avenue has been Hudson's Bay's best-performing chain by far. Through the first three quarters of fiscal 2018, Saks averaged comp sales gains of nearly 7%.
However, the late-2018 stock market meltdown may have pressured sales last quarter. While stock prices have recovered in 2019, it could take a while for wealthy consumers to return to the same level of spending. Furthermore, the strong dollar could depress international tourism in the U.S. this year. Tourists are a major source of sales for numerous Saks Fifth Avenue stores.
Offsetting these headwinds, Saks Fifth Avenue recently finished renovating the main floor of its Manhattan flagship, part of a multiyear, $250 million project to upgrade the store. This could boost its sales in 2019. On the other hand, the Saks Fifth Avenue flagship will face new competition starting next month from New York City's first Neiman Marcus store, followed by the opening of a new flagship Nordstrom store this fall. Time will tell if the renovation is sufficient to offset the impact of tougher competition.
Store productivity remains weak in Canada
The namesake chain of Hudson's Bay faces problems of its own, despite being the only major mass-market department store in Canada. A multiyear streak of comp sales growth ended last year. Furthermore, as of fiscal 2017 the company generated about half as much revenue in Canada as in the U.S., despite having more square footage in Canada.
The sale of the Lord & Taylor flagship was supposed to be part of a broader strategic alliance with WeWork that would include the latter renting a substantial amount of space at the Hudson's Bay flagship stores in Toronto and Vancouver. Indeed, Hudson's Bay's low sales per square foot suggests that it needs far less space than it currently occupies.
The WeWork offices in Toronto and Vancouver haven't opened yet and management hasn't mentioned this part of the WeWork deal on recent earnings calls. Finalizing this arrangement would be a good first step toward rationalizing Hudson's Bay's Canadian real estate footprint -- and the company has plenty more stores that could benefit from downsizing in the future.
Can management get the job done?
Hudson's Bay has turned over management of its European operations to SIGNA, but it still operates four major chains in North America: Saks Fifth Avenue, Lord & Taylor, Saks OFF 5TH, and Hudson's Bay. Of those four, only the first is truly performing well right now.
Thus, management faces a tough task, as it must try to simultaneously turn around multiple retail banners that participate in different market segments. This will be a key year for determining whether that is realistic. If Hudson's Bay can't deliver improved sales and profitability this year, the conglomerate may need to take even more aggressive actions to pare down its portfolio so it can focus on its biggest opportunities.