The End of Retail As We Know It?

Not a week goes by without news of another retailer seeing its stock price pummeled. So is this the end of retail as we know it?

Yes, and maybe no.

While some retailers are going belly-up, the stock market tends to paint all companies in a struggling industry with a broad brush. But it’s likely some will continue to be successful. The problem is stock investors in general don’t know which ones. If a sector comes under pressure, investors tend to sell everything in the sector … the good with the bad. 

It’s true that many physical retail businesses are struggling. Recent bankruptcy victims include: Toys R Us, Sports Authority, Radio Shack, Payless Shoe Source, Gymboree, Gander Mountain, True Religion Apparel and The Limited. What’s really happening is the pressure from online sales is exposing the weakest of the physical retailers. First, many retailers have too much physical space, which is expensive to maintain. The U.S. has about six times the physical retail space per capita as most of Europe. Retailers with lots of space will have a hard time building a competitive digital presence. The fixed costs for physical space suck up all the cash flow, leaving little to invest in online infrastructure.  

Many retailers have relied on the convenience of their physical locations for sales. Unfortunately, the advantage of the prime retail location is eroding with digital platforms. Yet, they still carry all the legacy costs of those physical locations. When an industry changes rapidly, those with high fixed costs and entrenched management usually are hurt the most.

So is there hope for some retailers?

While many investors fear that online retailing will gut business models for physical retailers, the reality is that currently 90 percent of retail sales in the U.S. are made in physical stores. It’s likely the best retailers will figure out an appropriate mix of online and in-store sales that fit for the products they are selling. For instance, if you sell sacks of cement, sheets of plywood or landscaping rocks, you won’t need much of an online presence. But if you sell clothing, housewares and many other things that can be easily shipped and returned, you’ll likely need a blended business model.

Consumers like the convenience.

For investors who are interested in trying to find the solid retailers, there are many branded retail companies that have solid profits, low debt, adequate cash flow, a growing digital platform, and even pay healthy dividends. Yet, many of them have still seen their stock prices fall by 50 percent, because in general, investors have little faith that these business models will succeed.  

If you want to invest in solid retailers at a bargain price, then you’ll need to do your fundamental research. That will help you identify the firms that are currently in good shape, but ultimately you’ll have to make a leap of faith about their business models. 

You’ll have to decide how much different the future will be from the past in terms of distribution and buying patterns.  If it’s completely different, then the current profitability for some retailers won’t provide much protection. If it’s somewhat different, like online sales grow to 30 percent of the market, then those retail firms that are nimble and are adjusting may well be worth the leap of faith at these bargain basement prices.

Also, don’t assume that the online retailers have it all figured out. Many are either barely profitable or not profitable at all. Wall Street is currently giving them a pass, but ultimately, profits will matter. I expect many online retailers will find out that just like with online dating, at some point, a physical presence is necessary to profitably promote your brand.

Disclosures.  Above material is for information and education purposes only.  Consult your individual financial advisor before making any financial decisions.  All investing involves the risk of permanent losses.  Past performance is not indicative of future returns.