Operating a retail establishment can be hard even in the best of times.
Now, it may be even harder as third quarter numbers are in, and the market punished retail stocks across the board late last week. How do retailers like Macy's(M 1.44%)keep up with changing consumer preferences and an ever intensifying competitive landscape?
On this video segment, Motley Fool analysts Sean O'Reilly and Vincent Shen discuss the rough year that retailers have had so far and the steps they are taking to drive revenue.
A full transcript follows the video.
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This video was recorded on Nov. 10, 2015.
Sean O'Reilly: I do want to look toward the future for these companies and the shifting consumer spending toward more media, more electronics, as opposed to spending an afternoon shopping at Macy's. Apparently these companies do have value though.
Vincent Shen: Oh, of course. So there's two trends that we're seeing for these apparel retailers that I also think, that are much longer term, are something that we're kind of getting the beginning hints of that investors will want to keep in mind. And the first is that there is a shift from spending on a lot of traditional goods like clothing toward media, and also electronics.
A good example of where we've already seen this start to take hold -- and the companies are suffering as a result, and they've had to basically institute major transitions in their business and their product portfolios -- is the toy industry.
So, think about like Mattel, for example, or Hasbro, where they had these major brands like Lego -- like Barbie, I'm sorry, not Lego -- like Barbie or Hot Wheels or the American Girl dolls. Those have all struggled, and I see it every time I visit my little cousin, for example.
O'Reilly: Why buy those when you can give the kid an iPad?
Shen: Exactly, and he's on his iPad most of the time over playing with the typical action figures or some games along those lines. So, that's just something that we've seen in general, and I think is going to start leaking into the apparel retailers as well, where people are just going to be focused more on getting the latest iPhone rather than getting a new pair of boots.
O'Reilly: Well, not only that, but these companies are, and this is harking back to what we were talking about earlier with the smaller format stores and having less inventory and everything. I did want to point out that I love what Macy's has done.
And I don't know if you came across this in your research, but they just built a $300 million or $400 million distribution facility in Oklahoma of all places that pretty much rivals an Amazon warehouse. Macy's is on it with their inventory management and their distribution. And just with the way the country's working with getting things in two or three days buying on Amazon, you don't need a huge store. You don't.
Shen: And I'm glad you brought that up, because that's another big trend that we're [seeing], a big shift that we're seeing for these companies is Macy's is being really proactive about adopting this omnichannel strategy, where they are meeting customer's needs in the store and online. Because there's no denying that e-commerce has obviously been growing as a percentage of total retail sales for a long, long time now.
O'Reilly: Well arguably, everybody wins, because if you go into a Macy's or any one of these stores 20 years ago, they literally had to have every size of a pair of jeans available pretty much if they wanted that sale that day. Now they can have five of the sizes. If the person likes it, they can just be like, "OK, order online, we'll be at your place in two days." Boom.
Shen: Or pick it up at the store.
O'Reilly: Either way.
Shen: So they really want to provide shoppers with those options. Kohl's hasn't been as strong as some of the other, some of its competitors in adopting that omnichannel strategy, but it definitely has it in mind, and management has cited the fact that they're going to be pursuing that much more aggressively. And so the last thing is a bit more of like financial engineering in my view. But it has to do with REITs, real estate investment trusts. We kind of saw this a little bit in the gaming industry with Penn National Gaming.
O'Reilly: A couple years ago, yeah.
Shen: Where they basically have these casinos, they spun off a REIT which basically owned that property, and the actual casino operator would lease that back. The benefit? The investors in the REIT get really stable revenues from those lease payments, but they also get more favorable tax treatment since it's not taxed at that level.
O'Reilly: At the corporate level.
Shen: Exactly.
O'Reilly: So, a number of retailers are all of a sudden doing this. The first bull case that referred to any of these comments was of course Sears. Hasn't turned out quite as well but a lot of analysts have come out and said that they think that the real estate at some of these other ones, particularly the stronger brands like Macy's, are worth even more than the Sears locations.
Shen: So Jeffrey Smith, he's an activist investor with Starboard Value, and this is a pretty impressive number. He thinks that Macy's real estate ... I just think about its flagship store, for example, in New York.
O'Reilly: That's worth a billion dollars on its own, right?
Shen: He thinks that the real estate [portfolio] for Macy's is worth $21 billion. The company's market cap right now is just $15 billion.
O'Reilly: Now did he say what ... OK, so you can throw that number out. Okay all Macy's stores are worth $21 billion for their real estate. However, you need to have a use for it to get the real estate value. To get the value out of real estate, one of the bull cases I remember, one or two years ago, was Sears. They wanted to chop up the stores and to make them into tiny little stores. You'd have like a Best Buy mobile and all that stuff. Is that what he's thinking with the Macy's stores?
Shen: Well the thing is, overall, the company, the management team, has already started to think about the property they own and the ways they can diversify its use. I think at another location, they kind of took the second floor and just started renting that out to another tenant.
O'Reilly: Wow, who was it?
Shen: I don't recall. But that was just something that I had seen quickly. But it's just part, overall, I look at it more so as the fact that these companies currently in their current form, they own a lot of property and a lot of real estate, obviously. And whether something like a REIT can help unlock that value is definitely something investors should consider.
