Can 2017 Be A Good Year For Retail Stocks?

Declining mall traffic and low prices offered by fast fashion retailers have been crushing apparel retailers. Recent years have been hard for these companies, with some even filing for Chapter 11 bankruptcy, such as Quicksilver in September 2015, Pacific Sunwear in April 2016, and Aeropostale in May 2016. Earlier in the year, news also surfaced regarding the shuttering of The Limited. Others have hobbled along, including Abercrombie & Fitch, and Gap Inc. These once sought-after brands, among high school kids in the US, have been blighted as a result of their over-reliance on the footfall at shopping malls, and the rise of fast-fashion brands, such as H&M and Zara. Moreover, these companies have failed to adapt to the rise of social media platforms, where teenagers currently spend a majority of their time. The S&P 500 retail Index also underperformed in 2016, as compared to the growth in the S&P 500. The S&P Retail ETF provided an annual return of 3.30% in 2016, versus the 11.80% return attained on the S&P 500 ETF. However, looking ahead, 2017 may prove to be a good year for the retail industry. Below we’ll highlight some factors that may result in a positive performance in the sector’s stocks.

1. Increasing E-Commerce Revenues

With growing internet penetration, a consistent customer shift from store to web shopping, and the proliferation of smartphones and tablets, the growth in online shopping has been massive. Online retail sales in the U.S. have grown at a rapid pace over the past several years, thanks to growing internet usage in the country. Internet penetration in the U.S. has gone up from 44% in 2000 to 88.5% currently. Furthermore, facilitated by the convenience of constant access, 92% of teens today go online daily, including 24% who are online constantly, according to a study conducted by Pew Research Center. Over half of the teens (aged 13 to 17 years) go online several times a day, aided by the presence of smartphones, which are available to nearly three-quarters of teens.

The smartphone usage will only increase in the future, and this will likely result in a steady rise in online sales. This is evidenced by research which predicts online apparel sales in the US to increase its revenue from $63 billion in 2015 to $100 billion by 2019. This segment is considered as the most popular e-commerce category in the US, accounting for 17.2% of total e-retail sales in 2015.

The US apparel industry is gradually shifting towards omni-channel retailing, which refers to providing a seamless shopping experience across stores and the online channel. This is becoming an inevitable move for these companies, including American Eagle, which is working hard to develop its omni-channel platform and has shown significant progress so far. On a total company basis, the DTC business now accounts for 31% of the sales, as compared to 28% last year. This lends credence to its decision to develop its omni-channel presence by investing in digital marketing, and improve its website and mobile app.

Even for Urban Outfitters, in recent quarters, the comparable sales growth has been driven by its direct-to-consumer (DTC) channel, partially offset by negative comparable store net sales. This means that the e-commerce segment of the company has been mainly responsible for the sales growth, with the physical stores actually losing ground. In the most recent quarter (ended December 2016), the company again reported that the comparable sales were driven by strong, double-digit growth in the direct-to-consumer (DTC) channel, but were offset by negative retail store comparable sales. This implies that fewer customers are coming to the stores, and are buying less when they do.

2. Decrease In Footprint To Improve Margins

In the face of the realization that millennials don’t want to go to malls, many mall-based retailers have announced several rounds of store closures in recent times. Retail analyst Jan Rogers Kniffen told CNBC in May of last year that he predicts 400 of the 1,100 enclosed malls in the US will close in the coming years, and only 250 of the remaining will thrive. He further noted that since the US has an estimated 48 square feet of retail space per citizen, the footprint is poised to decline “pretty fast.” This scenario is also reflected in upscale retailer Neiman Marcus pulling out of its proposed IPO, amid a weaker customer demand. This decision was undertaken two years after the company filed its intent with the US regulators to go public.

Given this trend, Gap has shuttered a number of stores in the past few years; over 100 each year between 2011 and 2014, 237 in FY 2015, and another 217 in FY 2016. With the growth of e-commerce and m-commerce, the company is putting greater focus on these channels, with efforts being made to improve site speed, and having richer content. For Abercrombie & Fitch, in 2017, the company expects to close approximately 60 stores in the US through natural lease expirations. Additionally, with about 50% of the US leases expiring by the end of FY 2018, the company has significant flexibility to strike the right store count balance, and drive efficiency by remodeling or resizing the stores, renegotiating leases, or shuttering down. This closure follows the 53 other shops that were shut in FY 2016, and the many others closed in the years prior. In theory, the company’s comparable sales should show an improvement when the unprofitable stores are closed down.

3. Better Valuations

As investors continue to be bearish about retail stocks, and as the apparel companies continue to miss earning estimates, their stock prices have steadily declined. These companies seem to be struggling in the face of declining footfall in malls and the rise of fast fashion retailers, such as Zara and H&M, and consequently, their poor performance has been reflected in the pummeling of their stock price. However, one upside for these stocks in all this is that as the valuations have fallen, the yield has increased. Hence, these may look to be decent investments for dividend purposes. Some examples of this have been highlighted in the table below. Furthermore, looking at the payout ratio, we can also see that it is at a sustainable level, and hence, it would indicate that the dividend is indeed safe.

Have more questions about the retail industry? See the links below:

• Part 2: Is There A Way Out Of The Rut For Brick And Mortar Stores
• Retailing Conundrum, Part 1: Is There A Way Out Of The Rut For Brick And Mortar Stores?