MAY 08, 2017

Most of us are familiar with the many conveniences of shopping online. With a few clicks of your mouse or some taps on your phone, you can have any number of products brought straight to your door, sometimes within just a few hours. Prices are often lower online than in physical shops, and you don’t have to bother actually going to a store or waiting in any lines to get what you want.

There’s no question that the internet has changed the way many people shop. Unfortunately, the retail revolution hasn’t been so great for traditional brick-and-mortar stores. In fact, changes in the sector have led some industry observers to opine on the coming demise of the retail industry.

Is retail dead? It’s worth considering—not just because of nostalgia for the days of holiday displays in department store windows or shopping trips to Main Street, or even theoretical debates about changes in our economy, though those may be important. Investors who invest in retail stocks to gain exposure to the American consumer may also be wondering if they should look elsewhere.

So what’s going on here?

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Recent news from the world of old-school retailers hasn’t been great. Familiar names like J.C. Penny, Macy’s, Kmart and Sears have all announced store closings. The number of financially distressed U.S. retailers is at its highest level since the financial crisis and debt levels are soaring, according to a report released in February by Moody’s Investors Service.1 Bankruptcy is stalking the sector. S&P Global Market Intelligence found that nearly as many retailers had filed for bankruptcy by late April this year as had filed in all of 2016.2

Competition from online vendors has played a big role in these troubles. For example, in the first quarter this year, department store sales were down 6.6% from the same period last year, while sales by non-store retailers (i.e. online retailers) were up 11.2%, according to Census Bureau data.3

All this is also happening at a time when American consumers are in pretty fine shape. The jobless rate fell to a 10-year low in April, wages are edging up and consumer confidence is surging. This kind of environment makes retailers’ continued struggles all the more worrying.

Right-sizing for the future

It’s not all bad, though, and some caveats are in order. First of all, the retail sector covers a lot of different kinds of businesses, from auto parts stores and gas stations to home furnishing stores. While department stores and general merchandise stores have struggled, other retail businesses, including auto parts dealers, have seen their sales grow and are actually hiring.

It’s also worth noting that although e-commerce’s share of total retail sales has been marching steadily higher since the early 2000’s, it still accounts for less than 9% of overall sales, according to the Census Bureau. Again, that has come mainly at the expense of department stores.

Finally, there’s the fact that American retailers simply have too many stores for the current environment. The store closures mentioned above are evidence of a sector trying to work through this problem. And while not all of America’s troubled general retailers are likely to make it through this rough patch, some of them surely will and could be stronger for it.

Experience matters

So what might the in-store shopping experience of the future look like? Brad Sorensen, managing director of Market and Sector Analysis for the Schwab Center for Financial Research, says the coffee business might offer a few clues.

“Not too long ago, most coffee was brewed either at home or work, or picked up from a fast food restaurant or gas station, and there was no reason to think Americans would suddenly stop enjoying the convenience and ‘quality’ of instant coffee,” he says. “Fast-forward a few years and many people now prefer to wait in line at a shop for the privilege of paying substantially more for that same caffeine fix. Why? Quality and the ‘experience’ likely have a lot to do with it.”

“Throwing products out on a table and waiting for people to come and get them is likely not going to work very well anymore, he adds. “There are too many options out there.”

The rise of mobile device-based shopping also creates opportunities for retailers that can successfully integrate their physical locations with a mobile platform, Brad says. A report by retailer researcher bazaarvoice found that shoppers who interact with a retailer via multiple channels, such as through a mobile device and by visiting an actual store, spent 18%–36% more than those who dealt with just one channel, no matter what that channel was—leading us to believe there is a place for both.

“Shoppers will still want to be able to try on clothes, see the merchandise in person and have helpful, friendly sales people assist them,” Brad says. “Anyone that has tried to do a plumbing project knows that there will be at least a half dozen trips to the hardware store in the course of a day—and even overnight shipping isn’t good enough!”

Shopping for investments

The retailing sector will likely face more turmoil as a trimmed down and modernized industry reinvents itself. We don’t think investors should totally shun the sector, though. For investors looking for potential unloved areas, and who have the patience and desire to do the research, retail could offer some opportunities.

Of course, it doesn’t always pay to be contrarian—those who thought that buggy whips would stage a comeback because newfangled motorized vehicles would never last were likely pretty disappointed. That said, the gloom hanging over the retail sector may be obscuring some potential bright spots.

At the end of the day, a truly diversified portfolio should include exposure to variety of sectors, including retail, to avoid the risk of overconcentration and to give your portfolio the opportunity grow as the fortunes of the different sectors shift.

Moody’s Investors Service, “Distressed Retailers Are on the Rise; Who’s Next?,” 2/27/2017.

Jim Elder, “Risk Insight: 2017 Retail Bankruptcies Set Record Pace—Which Companies Are Most At Risk?,” S&P Global Market Intelligence, 4/20/2017.

“Advance Monthly Sales for Retail and Food services, March 2017,” Census Bureau, 4/14/2017.

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