Like shoppers bypassing a clearance rack, bidders have so far found little appeal in disfavored retail stocks — even as many chains have sunk to valuations that, in the past, would have enticed private buyers or strategic acquirers.
The question pervading the department store and specialty retail sector: Is consolidation simply a matter of time, or have concerns about structural shifts in consumer behavior made these companies appear too risky even for opportunistic buyers?
Poor comparable-store sales, weak traffic trends and downbeat comments by executives at companies such as Macy's, Nordstrom, Fossil Group and Urban Outfitters have resulted from some unknowable combination of an uninspired consumer, unusually warm spring weather and the steady encroachment of online shopping over browsing in stores.
Investors have brutalized a wide selection of stocks in traditional retail. While the SPDR Retail ETF (XRT) is off more than 10 percent this year, even that weak showing understates the damage, thanks to the huge gains in leading components Netflix and Amazon.com. More than a third of the stocks in the XRT are down more than 20 percent year to date.
Among the macro trends that have investors spurning the sector: Last quarter, online sales represented 7.4 percent of all retail activity, up from 5 percent at the start of 2012 and around 6.5 percent a year ago. The shift to Web and mobile shopping has accelerated a bit in the past few quarters, suggesting an ever-smaller pie for physical stores to fight over.
Meantime, the government's latest consumer price index released Tuesday showed that prices for apparel declined 1.9 percent in the past year, pressuring the top and bottom lines of the department store and specialty clothing chains.
The result is a pile-up of retail stocks that look cheap based on their own history, and compared to the valuations many retail companies have been acquired for in recent years. Private-equity firms in past cycles have rarely been able to resist swallowing up marquee retail properties, dating back to the 1980s. And present-day Macy's is itself the result of a roll-up strategy, uniting the former Federated Department Stores and May Department Stores, along with others.
As the nearby table shows, big department store operators and popular specialty chains are trading between nine and 12 times forecast earnings for the coming year, and have cash-flow multiples between four and six, as measured by enterprise value (market capitalization plus net debt) to earnings before interest, taxes, depreciation and amortization.
The latter ratio is the typical gauge of retail acquisition values. For comparison's sake, Ascena Retail Group — parent of Lane Bryant, Justice and other female-focused stores — this year agreed to pay around eight times EBITDA for Ann Taylor.
Two years ago, Sycamore Partners bought Jones Group for 8.5 times cash flow. According to Bloomberg, this is roughly the median multiple paid by acquirers for U.S. retail businesses in recent times. Going back a few years, J. Crew was taken private by TPG Capital and Leonard Green & Partners at a reported 14 times EBITDA, quite lofty by current standards.
The fact that such a gulf has opened between prevailing public-market multiples and past acquisition values suggests that potential buyers are concerned that the structural decline in physical retailing makes these companies a "value trap." In other words, maybe they're cheap for good reason and don't offer a debt-enabled financial buyer a proper margin of safety.
Added to this worry is the fact that bigger leveraged buyouts have been largely absent from the busy merger and acquisition scene this cycle. Regulatory constraints on banks and private-equity firms in "harvesting" mode have curtailed LBO activity.
Finally, the usual escape hatch of challenged retailers — reaping some value from extensive real estate holdings — is complicated by the waning appeal of mall and strip-center space. While Macy's sits on vast value in the form of its Midtown Manhattan flagship and is busy carving out spaces for smaller retailers and other tenants in anchor stores, the typical retailer is hard-pressed to find eager takers for its leases or boxes.
There is, too, the cautionary example of Sears Holdings, the combination of Kmart and the old Sears controlled for a decade by hedge-fund manager Edward S. Lampert. While Lampert has kept the holding company afloat through multiple asset sales, real estate deals and spinoffs, it's still unclear if enough value can be squeezed out to overcome the persistent sales declines at its core chains.
Gap remains an intriguing company in this whole discussion. The company has frequently faltered in driving comp-store sales, often with Old Navy serving as the only one of its three concepts reliably growing. The founding Fisher family continues to hold a large stake. The online business and workout-wear brand Athleta continue to have growth obscured by sluggish mall-store performance. And the company was reported to have considered going private in 2007.
Gap said it would not comment on rumors or speculation.
At some point, if industry trends should stabilize, these cheap-looking stocks could be viewed as offering two ways to win, either through a return to earnings growth or a premium-paying acquisition.
In the fog of today's retail environment, though, investors are now stubbornly focused on what more might be lost.