We could debate forever and a day about the viability of the department store business model, and the health of the consumer that shops there. Over the past year, that has not mattered. When capex is being cut by 20%, working capital is coming down by 15%, and SG&A by 5% -- the companies still have enough juice to the model even if sales are punk.
I’m so often hit with the argument that “if sales only bounce back, XYZ Co will see massive leverage on the operating profit line.” Yes, that’s probably true. IF sales bounce back. Some companies get lucky and temporarily realize this sales lift. But others invest in their models to drive it, and to sustain it. Unfortunately the department stores are banking on the former.
What do I mean?
Check out our SIGMA chart below, which layers the past 4 quarters for Macy’s, JC Penney, and Nordstrom on top of one another. As a reminder, the vertical axis measures the sales/inventory growth spread (i.e. 10% sales growth and 2% inventory growth = +8%), while the horizontal axis measures the year over year point change in margins. Observations…
1) All three companies are either in the sweet spot (positive sales/inv spread) or headed in that direction for at least 3 quarters. They’re going to have to start comping this. Nordstrom is the most problematic from my perspective.
2) Note that for EVERY one of them, the latest data point on this chart market a slight downtick. That’s very, very soon relative to other retailers who traced this path. We call that a negative divergence.
Also, can anyone explain to me why Macy’s and JC Penney are at their highest free cash flow margins in almost a decade. Yes, cash flow and working capital are at historic lows. This actually is not much of a problem overall for most companies. They simply come up with a proactive plan for taking capital, and allocating it throughout their model (including in SG&A) in a way that will drive the top line without increasing the volatility and risk on the gross margin line.
In other words to invest in these names, we need to value the growth, as opposed to value component.
Good luck with that.
I don’t like any of ‘em (KSS is the exception, and the one outlier that is managing their business right).
Add JWN, JCP, and M to the list of names we don’t like – incl DG, FDO, ROST and JNY.
Hedgeye Retail Team