Why closing stores isn't an easy fix for retailers

After closing nearly 600 stores in a one-year period, presumably removing the weakest locations from its footprint, sales at Sears Holdings stores that were open at least a year nonetheless slipped 8.6 percent during the third quarter.

This week, news of Kmart and Sears stores that will shuttered across the U.S. once again made headlines, as the department store chain aims to cut costs and focus on more profitable locations.

And Macy's, already under pressure from an activist investor who wants the department store to unlock value from its real estate, is preparing to close 36 more stores in early 2016 as it tries to jump-start its comparable sales results, which slid 4.7 percent in the November to December period.

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These are the latest retailers in a long line of names to prune their store fleet over the past few years. Still, analysts question whether companies are moving fast enough in removing trouble locations from their footprint.

At Aeropostale, for example, 84 locations were shuttered in a year's span. But same-store sales continued to tumble during the third quarter, dropping 10 percent. And though trends at J.C. Penney continue to improve, analysts said its comparable-sales growth should be more robust, particularly after it closed 40 stores in 2015.

In addition to these names, the Gap brand, which has shuttered roughly 40 of its North America stores over the past 12 months, plans to close a total of 175 here over the next few years. And last week, Finish Line said that it would close 150 stores by 2020 in an effort to boost its profitability.

Analysts expect more retailers to announce store closings throughout the first few months of the year, as they digest the results from their holiday and fourth-quarter sales. That's due, in part, to the fact that activist investors and others on Wall Street are growing increasingly impatient with retailers' reluctance to close unprofitable stores.

But while closing a store can help pad retailers' bottom lines — and appease investors in the process — the decisions should not be taken lightly. Not only does closing a store result in lost sales — and often, erosion of market share to a competitor — it can be costly and complicated to exit a lease prematurely. It also removes a point of distribution for the brand, as consumers increasingly expect to be able to pick up online orders in the store.

"It's a delicate balance," said Michael Burden, executive managing director at Excess Space Retail Services, an advisory firm that specializes in real estate disposition and lease restructuring. "I don't think any retailers are in real rushes to close their stores."

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For one thing, it can be extremely costly for retailers to break a lease early. In 2014, teen retailer Aeropostale acknowledged it took an after-tax charge of $5.5 million, or 7 cents per diluted share, over net lease costs. Similarly, Sears said in the third quarter that it took charges of $6 million related to store closures.

Meanwhile, although underperforming stores may be operating at a loss, they're still contributing millions of dollars in sales each year. Macy's, for example, said the 40 stores it has closed or are on the chopping block account for roughly $375 million in annual sales. And at Finish Line, the stores it plans to close generate roughly $1 million in average annual sales.

While both retailers are optimistic that some of these revenues will be picked up by nearby locations or online, Burden said in actuality, it never ends up translating dollar to dollar. What's more, retailers who close a location lose a chance to market their brand among that consumer base, and give up a point of distribution.

Further complicating the store closing process, Burden said, is that landlords are no longer willing to accept a lump-sum payment from retailers to allow them to exit a space early, unless they already have a replacement tenant in hand. That's because such a move forces them to take on unnecessary market risk, as it could result in a vacant storefront. What's more, there's a "significant tax consequence" to accepting one of these buyouts, he said.

"If the retailer finds a new tenant, the landlords, we've found, have been very cooperative," he said.

Anjee Solanki, national director of retail services at Colliers USA, said there's another reason why retailers should act prudently before caving to investor demand to close a large number of stores at once. Namely, to avoid creating a reputation among consumers that its business is flailing.

"If you start closing stores very quickly, what does that do from a perception standpoint?" she said. "Certainly you'll start to see closures occur quickly, but I don't think you want to force that. … When you have those conversations you're doing that retailer a disservice."

Solanki added that while she expects to see more store closings in 2016, they are of a healthier nature than last year, when retailers including Deb Shops and RadioShack closed hundreds or thousands of stores as part of their bankruptcy proceedings. Instead, she views many of the recent announcements as a means for retailers to get their square footage more in line with consumer demand, and in better locations.

She pointed to one of Macy's locations as an example, saying it's in a mall that should be reconfigured into an entirely new retail concept. She added that in many cases, stores that are being closed are in areas where the population has shifted into a nearby city, where the government has been investing money toward the area's growth. Burden added that much of the industry's consolidation has occurred as a result of mergers or acquisitions.

Still, questions remain as to whether retailers are divesting their underperforming properties quickly enough. Craig Johnson, president of Customer Growth Partners, said that while the decision by Macy's to hire Eastdil Secured to pursue potential real estate maneuvers, as well as search for a senior executive to manage real estate activities, it should have made those moves a year ago. In that vein, Evercore ISI analyst Omar Saad told investors in November that the timing for potential deals could take the retailer about a year.

"There are huge opportunities there, they've just got to get it ramped up," Johnson said.

Another option for retailers looking to trim their square footage is to sublease their space to a competitor, thereby transitioning them into the landlord role. But Burden cautioned that this results in retailers supplementing a portion of the rent roughly three-quarters of the time. Likewise, they can slice the store in half and bring in another tenant, but that means paying to put up a wall, separating the electricity and heating components and other logistical challenges.

Instead, Burden said over time, he expects retailers will start to close larger locations and move into smaller spaces. Along those lines, Target has been shuttering its big-box locations in favor of its smaller-format stores in places like New York City and Chicago. Likewise, Kohl's plans to test five to 10 smaller-format stores this year.

"It used to be let's just roll out 100 stores of this size in every market. Now the conversation has changed," Solanki said. "The retailer is customizing their concept for the market."