Lord & Taylor, the oldest department store chain in the U.S., has been struggling for years under the ownership of multinational retail conglomerate Hudson's Bay (NASDAQOTH:HBAYF). Hudson's Bay has closed a handful of Lord & Taylor stores and installed a new management team, but so far, there have been no obvious signs of improvement.
As a result, Hudson's Bay may be ready to face the uncomfortable truth that the Lord & Taylor brand is beyond saving. On Monday, the company announced that it is studying "strategic alternatives" for this perennially underperforming piece of its retail empire.
The situation at Lord & Taylor today
Hudson's Bay doesn't report results for the Lord & Taylor chain specifically, so investors must rely on educated guesses about how it's doing.
What we do know is that Hudson's Bay reported an overall adjusted EBITDA margin of just 3.6% last year. Given that Lord & Taylor has experienced steady sales erosion for years -- whereas the Saks Fifth Avenue and Hudson's Bay chains have performed better -- it's virtually certain that Lord & Taylor's adjusted EBITDA margin is far lower than the corporate average and possibly negative.
Including interest expense and the cost of capital investments, it's even more clear that Lord & Taylor is bleeding cash. The chain certainly isn't profitable enough to justify the capital tied up in operating its stores, not to mention the distraction it creates for Hudson's Bay's management.
In response to Lord & Taylor's struggles, Hudson's Bay recently closed the brand's flagship store in Manhattan and sold it to a WeWork affiliate for $850 million. It has also closed several other underperforming stores since the beginning of 2018, reaping modest real estate gains.
Meanwhile, Hudson's Bay opened up a new, highly automated e-commerce fulfillment center for Lord & Taylor in Pennsylvania to support online growth. It also partnered with Walmart (NYSE:WMT) to launch a Lord & Taylor storefront on the Walmart.com site last year. The goal is to drive growth by pairing Walmart's broad reach with Lord & Taylor's access to premium brands.
Hudson's Bay gets serious about Lord & Taylor
The decision to pursue strategic alternatives for Lord & Taylor suggests that the brand's financial performance continues to deteriorate. In its press release, Hudson's Bay alluded to "a possible sale or merger" as potential outcomes.
However, given the brand's weak (or nonexistent) profitability and downward sales trajectory, nobody is likely to offer very much money to buy Lord & Taylor lock, stock, and barrel.
That said, the remaining 45 Lord & Taylor stores sit on valuable real estate. Unsurprisingly, Hudson's Bay is testing the waters with mall owners and other real estate investors about buying back store leases from Lord & Taylor and redeveloping Lord & Taylor stores for other uses, according to a recent Wall Street Journal report. Most of the stores are in strong malls in high-income areas, so the potential real estate value likely totals hundreds of millions of dollars, net of debt and minority interests.
If Hudson's Bay sells the Lord & Taylor real estate, Walmart might be interested in paying a modest sum to buy the brand itself. In recent years, the retail behemoth has made a steady string of acquisitions to boost its e-commerce growth and attract new customers who wouldn't typically shop at Walmart. Buying Lord & Taylor as a pure e-commerce play could be a natural extension of that strategy, given the existing partnership between the two brands.
Something has to change
There are plenty of ways that Hudson's Bay could potentially address the underperformance of its Lord & Taylor chain. Selling the real estate and the brand separately seems like the most straightforward solution, but a radical downsizing of the chain -- without exiting the business entirely -- might be a viable alternative. Or, a serious buyer willing to pay full value for Lord & Taylor (including its real estate) could come out of the woodwork unexpectedly.
However, it's clear that the turnaround moves implemented so far at Lord & Taylor have been thoroughly inadequate. Hudson's Bay has made a lot of tough but necessary restructuring decisions over the past year, and it's a good sign for shareholders that the company is finally confronting the Lord & Taylor problem head-on.