Despite the doom-and-gloom predictions about the future of big-box retail that are dominating headlines lately, some analysts are bullish about select real estate opportunities and those brick-and-mortar retailers with high customer-satisfaction and engagement ratings in the coming year.
"The death of retail has been exaggerated," said Jay Rollins, managing principal of JCR Capital, which invests in value-add, "urban infill" and neighborhood retail center real estate for short-term returns of 15 percent to 20 percent.
"Neighborhood retail is convenient to everyone's daily life; you're going to a dry cleaner, a liquor store and a nail salon, [and] maybe a restaurant," Rollins said, noting that these types of business are integrated into people's lives for their daily needs.
"It's about the three- to five-mile concentric circle around a neighborhood; it's convenience retail versus destination," he added. "Can you push a button, and have a drone drop you a bottle of Jack Daniels in 10 minutes? That would be a game changer."
Retail — even brick-and-mortar retail — would be difficult to sink altogether. The industry directly provides 29 million jobs and contributes more than $1 billion annually to U.S. gross domestic product — mostly due to smaller businesses, according to a study by PricewaterhouseCoopers for the National Retail Federation. About 95 percent of retailers operate just one location and almost 99 percent of retail businesses employ fewer than 50 people. Consumer spending accounts for about 60 percent of the U.S. economy, according to financial analysis firm Sageworks.
While retail sales growth is down to about 3.8 percent in 2017, compared to 6.7 percent in 2013, net profit margins have risen to 3.3 percent, up from 2.3 percent, Sageworks reports.
The shopping habits of millennials — born between 1980 and 2000 and now the largest generation — are driving many retail trends. About 82 percent of millennials said they actually prefer brick-and-mortar shopping, consulting firm Accenture found. In Accenture's survey of retail industry leaders, about 40 percent of respondents said they are most concerned about millennials' lack of loyalty.
However, the consulting firm found that millennials are, in fact, exceptionally loyal when they are happy. More than 95 percent of millennials said they want the brands they like to actively court them and that they seek out personalized promotions and loyalty programs.
That's why in just over 18 percent of consumer discretionary holdings, ACSI Funds' American Customer Satisfaction Core Alpha ETF is made up of retail companies that pass a series of customer satisfaction metrics to determine how likely a company's customers are to remain loyal, as determined by its underlying index. Among the fund's holdings are Amazon, Dollar Tree, Costco and L Brands.
"It's no secret that there is some contraction in the retail space," said Phil Bak, CEO of ACSI Funds. "We don't think retail is going to evaporate altogether."
For his part, certified financial planner Mark Painter, founder of EverGuide Financial Group, says there's value in many areas but picking winners and losers is difficult. "Remember when Ron Johnson took over at JCP in November 2011 and the stock instantly went from $30 to $43 a share in the span of three months on the promise of brand change and strategy?" Painter asked. "Two CEOs later and a stock price near $3, it is still trying to right the ship."
Because of such low prices of some retail stocks, investors should be weary of "value traps," said Daniel Lugasi, portfolio manager at VL Capital Management. "We believe the most insulated retail companies are those that offer a differentiated service than a company such as Amazon, can provide," he noted, pointing to TJ Maxx /HomeGoods and Ross as prime examples of "differentiated" shopping experiences because they offer discounted products curated for shoppers. TJ Maxx trades at a P/E of 19x because it is a well-run retailer, Lugasi noted, adding that "value traps, such as Macy's, are trading at a P/E of 9x earnings, but the business is in decline" by other indicators.
Aash Shah, senior portfolio manager for Summit Global Investments, recommends examining sales growth, earnings growth, cash flow growth and valuations together of each retailer. In a review of 35 major retailers in the Russell 1000 Index, which is made up the 1,000 largest U.S. public companies, Shah said sales growth in the last year averaged less than 5 percent with median at an "anemic" 3.5 percent. By contrast, Amazon grew revenues 27 percent.
"The median earnings growth for the group of retailers for the past year was also a sluggish 4.2 percent," he said, noting that cash flow — represented by earnings before interest, taxes, depreciation and amortization — was even worse, with a median growth of 1.7 percent.
"Why pay 16 times earnings for such mediocre growth prospects?" Shah added.
Shah's Summit Global Investments holds stocks of both Wal-Mart and Costco.
"As we have seen, the traditional anchor stores at malls have come under considerable pressure over the last few years," said VL Capital Management's Lugasi, citing Macy's, Sears, JCPenney, Nordstrom and Dillard's.
"Their footprints are so large, and rent typically constitutes one of their largest operating expenses," he added. "Over time, what we have seen is this pressure spread to smaller format stores that are located within shopping malls."
By some estimates, the U.S. has 10 to 15 times the retail floor space per capita than all other major economies except Canada, according to Shah. Eight major mall real estate investment trusts are also down this year, and premium mall operators represented by Simon Properties Group are down 10 percent or more, he said.
Concurrently, such brands are also failing to connect with customers or offer them things they can't get elsewhere, according to Rollins of JCR Capital.
Retail ETF performance is also mixed, with Amazon being a necessary anchor: The SPDR S&P Retail ETF is trading at about $41.55, compared with about $41.58 last year (top holdings: Tailored Brands, Group 1 Automotive, L Brands and Amazon), while the VanEck Vectors Retail ETF is up to $85.12, compared with about $77.42 last year (top holdings: Amazon, Home Depot, Wal-Mart, Lowe's, Costco, Sysco and Target). The First Trust Nasdaq Retail ETF started last fall has returned about -2.45 percent.
"Picking the turnaround stories in retail will be a guessing game, but the owners of that real estate will be the real winners, as they have shed market cap quickly, as well," said EverGuide's Painter, who suggests Brixmor Property Group, which has more grocery store anchor tenants and pays a 6 percent dividend. "Focusing on some of the REITs that do not have large debt maturities in the near future will be the best bet."