Over the past five years, top department store operator Macy's (NYSE:M) has gradually trimmed its store count, closing 52 Macy's stores while only opening 12 new ones. On Tuesday, the retailer announced that it plans to double down on that strategy by closing 35-40 stores in early 2016.
E-commerce drives sales at Macy's
Macy's has been one of the top-performing department stores since the Great Recession. One big reason for its success has been its "omnichannel" strategy. By aligning its in-store and online product assortments, Macy's has enabled customers to seamlessly purchase items through either channel: whichever one best meets the customer's needs. Macy's also invested in technology to improve its online sales.
The result is that Macy's did about $2.25 billion in online sales in 2011, according to Internet Retailer. E-commerce sales rose another 41% in 2012.
While Macy's has stopped reporting online sales growth since then, even a slowdown to 20% annual growth for the past few years would put the current annual run rate for online sales in the $5 billion-$6 billion range, about 20% of the company total.
Shifting importance of physical stores
Under Macy's omnichannel strategy, physical stores remain very important. In addition to being the primary point of sale, the stores also serve as showrooms for merchandise that can also be bought online and as mini-warehouses for fulfilling online orders.
That said, while Macy's still needs a large store base to execute its omnichannel strategy, its fleet of 770 Macy's stores is more than adequate for this purpose. The company can afford to close some underperforming locations without damaging its competitiveness.
Indeed, while Macy's will close about 4%-5% of its stores, it only expects to lose about $300 million in annual sales (1% of the company total). This indicates that it is primarily looking to close smaller, lower-volume stores. With less space, these stores probably carry fewer products, making them less effective as showrooms and as fulfillment centers -- and making them more expendable.
Closing stores will help manage costs
Last quarter, Macy's reported disappointing sales and earnings results. EPS declined 20% year over year in Q2 and 15% year over year for the first half of the year as a whole.
The drop was largely attributable to a 1.7% decline in sales during the first half of 2015. This meant that Macy's had less revenue to cover its operating expenses, causing significant margin contraction. Macy's also slashed its full-year sales guidance by 2 percentage points.
Closing stores will thus help Macy's reduce its cost structure in line with demand and operate more efficiently. And as it will continue to have a large store footprint across the U.S. and a big online presence, Macy's should be able to retain a significant proportion of the sales volume from the stores it is closing. That's a key reason why it expects such a small impact on net sales.
Looking for growth elsewhere
Even though Macy's won't lose a very large amount of sales from its upcoming store closures, many investors may wonder whether the company has given up on sales growth.
However, a better way of thinking about Macy's strategy is that it is turning to new areas for growth. Earlier this year, it purchased Bluemercury, an upscale beauty retailer. Macy's plans to accelerate the growth of stand-alone Bluemercury stores while also adding Bluemercury products to Macy's full-line stores over time.
Another exciting growth lever is Macy's new off-price format, called Macy's Backstage. The first three stores opened earlier this month, with several more opening later this fall. Macy's will need to do some testing and learning to perfect this store concept, but off-price retail represents a huge and growing portion of the fashion retail market today. This could therefore become a meaningful long-term growth driver.
Finally, Macy's is taking its first tentative steps into China later this year. The company recently set up a joint venture with Fung Retailing to test e-commerce sales in China. If the test is successful, Macy's could even open some physical stores in China in the long run.
In short, Macy's is still pursuing sales growth, but it is focusing on its most promising opportunities. Low-volume stores don't fit the bill -- they are costly to operate and customers can either go to larger nearby Macy's stores or buy online instead. Closing these locations is likely to be a good move for Macy's in the long run.