Macy’s Inc. and Kohl’s Corp. were downgraded Wednesday to sell from neutral at UBS, with analysts putting their confidence in brands that are able to capture sales on their own rather than relying on third-party sellers like department stores.
The coronavirus pandemic is accelerating the consumer shift to e-commerce, and UBS forecasts that many stores will shutter for good.
“To deliver steady long-term growth, we believe brands can no longer rely on malls or department stores to drive traffic,” analysts led by Jay Sole wrote. “Brands have to generate their own audiences and become destinations.”
UBS has six brands that it rates buy for their ability to generate sales on their own: Nike Inc. US:NKE ; Levi Strauss & Co. US:LEVI ; Skechers Inc. US:SKX , which reports its second-quarter earnings on Thursday; American Eagle Outfitters Inc. US:AEO ; Calvin Klein parent PVH Corp. US:PVH ; and Michael Kors parent Capri Holdings Ltd. US:CPRI
“We define ‘premium’ to mean a company’s value proposition allows it to earn a high gross margin,” UBS said. “This enables a company to have a profitable direct-to-consumer (DTC) business.”
With increased control over their branding and inventory, these “premium” brands can drive customer loyalty and “strong returns” that will help them to maintain high margins, analysts said.
“We think the ‘Go It Alone’ moment has arrived,” UBS said. “This means brands should plan for a future that does not rely on department stores or malls to help generate traffic or drive growth. The ideal business model will be one where a brand can profitably sell directly to consumers either online or in-store.”
All of this is bad news for department stores that are unable to compete with other brands and retailers.
“Brands are increasingly keeping the highest quality merchandise for their own channels,” UBS said. “Off-price [like TJX Cos. US:TJX ] has the best value for money. Online pure-plays like Amazon US:AMZN have the widest selection. The mass channel (e.g. Walmart US:WMT ) offers the lowest prices.”
UBS forecasts that department stores will account for 13% of the North American market share for clothes, shoes and accessories by 2024. Department stores accounted for 47% of market share in 2003, it estimates.
“The COVID-19 crisis came during an already tough time for department stores,” wrote Bank of America analysts in a recent note.
Weak mall traffic hurt sales, and the shift to e-commerce had already begun before the pandemic. With stores closed, department stores had to shift their priorities to liquidity rather than investing in their businesses to keep up with the competition and changing consumer trends.
In March, Macy’s drew down all of its $1.5 billion in credit. Macy’s and Kohl’s were expected to spend hundreds of millions of dollars on labor with all stores closed. Cowen analysts anticipated that the retailers had about five months of available cash.
At the beginning of July, Macy’s reported losses and revenue in line with expectations.
Kohl’s has reported to a first-quarter loss as well, and missed the FactSet revenue consensus.
“We expect the investment cycle to continue indefinitely, as department stores play catch-up on store investments and also chase new technologies to remain competitive,” wrote Bank of America analysts led by Lorraine Hutchinson.
“However, the budgets available to do so have shrunk, as department stores have had to lever up amidst the COVID-19 crisis in order to shore up their balance sheets. Unfortunately, in our view, department stores that do not keep pace with technological advancements and consumers’ demand for increased convenience are at a competitive disadvantage.”
The path ahead will be tough as well, with consumer confidence shaky and unemployment rates high. Surges in coronavirus cases in a number of states are also putting the brakes on a recovery.
“The challenges of debt will result in a slew of bankruptcies, namely mall-based apparel retailers and department stores,” wrote CFRA analyst Camilla Yanushevsky in a report from earlier this month. “Failing retailers are generally highly leveraged and grappling with deteriorating cash flows and weak profitability. Burdened by high debt-servicing costs, many have little wiggle room to invest in new technologies or evolve their business model.”
Among the retailers that CFRA says are “among the most highly leveraged retailers and face elevated bankruptcy risks” are Macy’s, Kohl’s, Dillard’s Inc. US:DDS , Nordstrom Inc. US:JWN and Victoria’s Secret parent, L Brands Inc. US:LB .
Macy’s stock has slumped 62% for the year to date. Kohl’s is down nearly 58%. The ProShares Decline of the Retail Store ETF US:EMTY has fallen 9.6% for the period, and the S&P 500 index US:SPX has gained 1.4% so far in 2020.