Short sellers who made big bets against US retailers a couple of years ago had hoped for carnage across the board. No one could compete with the rise and rise of Amazon, the theory went, which would make life hard for every mall tenant across America.
But after a period in which internet shopping seemed to hit almost every brick-and-mortar retailer, the industry seems to be dividing into winners and losers. Casualties are still piling up: bankruptcies since the turn of the year include footwear retailer Payless ShoeSource, the young women’s clothing specialist Charlotte Russe, and general merchandiser Shopko. Sears, the once dominant department store chain, narrowly avoided outright liquidation.
However, some of the biggest companies in the sector such as Walmart are reporting their healthiest metrics in years. The wholesale club Costco, for instance, is expected next week to report a 19 per cent rise in quarterly earnings. For short sellers trying to profit from falling share prices, it makes for a perilous environment.
“It’s a slow death by a thousand paper cuts, and not the kind of ‘mall-mageddon’ originally anticipated by that trade,” says Michael Arone, chief investment strategist at State Street Global Advisors. “Retail has been much more volatile than many would have have expected. It hasn’t been decidedly one way down.”
Fears that the relentless growth of Amazon would obliterate much of the sector reached fever pitch in the summer of 2017, when SPDR S&P Retail — the sector’s benchmark exchange-traded fund — hit a four-year low. The fund, known as XRT, has since rallied by a fifth.
“There was an over-reaction in 2017 and that led to pretty nice opportunities [for longs] in 2018,” says Jim Tierney, chief investment officer of Alliance Bernstein’s US Concentrated Growth fund.
Investors who put money on the demise of retail that summer have lost out in many cases. Between then and last week, on a mark-to-market basis, short-sellers were down a total $562m on Home Depot, $863m on Kohl’s and $885m on Target, according to data from S3 Partners. Only on a smaller selection of companies, including Bed Bath & Beyond, JCPenney and Gamestop, has the trade paid off over that time frame.
“It was almost as if they [shorts] were acting like no retail real estate space can work,” says Brad Lamensdorf, portfolio manager at Ranger Alternative Management. “That’s not the way we’re looking at it. There’s too much capacity, but that doesn’t mean retail real estate is dead.”
Shares in the sector have been volatile in part because investors have had to consider a series of seemingly contradictory data points about the health of both the US consumer and the retail business. XRT lost as much as 27 per cent last year from its peak, but has since rebounded 18 per cent.
For now, a robust economy has kept Americans spending both online and in stores. “Wages are still pretty good, unemployment rates low, [and] gas prices are down,” said Brett Biggs, Walmart’s chief financial officer, last week. The country’s biggest retailer had just reported its biggest rise in fourth quarter like-for-like sales in a decade.
Traditional chains are also trying to take on Amazon by improving their online offerings and making their stores more enticing. Both require hefty investment, although successful examples include Lululemon, which offers yoga lessons in its stores. Shares in the company have tripled since a 2017 low.
“Those who are innovating and investing in ecommerce, marketing and social media tend to be doing well,” says Ken Murphy, fund manager at Aberdeen Standard Investments.
He adds, though, that several retailers are under “incredible financial stress”. He points to the department store chain JCPenney, whose $4.2bn long-term debt burden as of November compares with a current market capitalisation of just under $380m.
Bears have no shortage of gloomy developments to support their case.
A profit warning from Macy’s last month triggered the biggest sell-off in its shares since its 1992 stock market launch. Government data this month showed US retail sales fell in December month-on-month by the most since 2009, although the figures were so bad that much of Wall Street questioned their accuracy.
Investors will learn more over the next couple of weeks, when dozens of constituents of the XRT are scheduled to report earnings. In anticipation, bears this month staked out the most aggressive short positions in a year against XRT, according to S3 Partners.
In several cases, argues Mr Lamensdorf, the market was still failing to price in the “Amazon effect”. He has shorts on retailers including Gap — “their footprint is too big”, a concept that is “easily copied” and a brand that has “lost its identity” — and the children’s clothes chain Carters. While he is not short JCPenney, he says the company has “massive over capacity.”
Whatever the shape of the economy, adds Mr Tierney, structural problems remain.
“The US is still over-stored,” he says. Ecommerce meant “more of the store base is not economic. That’s going be a secular pressure for years to come. For those retailers that don’t have a digital strategy, it’s just a matter of time before they fall.”