department store

Department Stores

Industry Insight

Date October 2016

Approximate net recovery on cost

Synopsis

Current trends

  • Since 2013, more than 700 department stores have closed. An estimated 150 of those closures will happen this year with another 145 already planned for 2017, according to RBC Capital Markets.
  • Retail sales ticked up 0.6 percent in September, which was 2.7 percent higher than the same period in 2015. This continues a pattern of steady year-over-year growth seen since January. However, department stores have bucked this trend, posting consistent declines. During the first nine months of the year, department stores averaged 5 percent lower growth over 2015.
  • In response to this troubling trend, retailers have closed stores, focused on improving in-store shopping experiences, and boosted e-commerce efforts. Non-store retailers averaged 11 percent year-over-year growth during the first three quarters.

 

Projected Values

 

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Technology challenges traditional brick & mortar: Online sales have continued to outpace retail sales this year, led by Amazon. In its first and second quarter of 2016, Amazon’s sales were up 28 and 31 percent, respectively. Growing logistics infrastructure and innovation in its delivery business ensure that it will continue to be a driver of change. To compete, department stores must find ways to integrate brick-and-mortar and online channels, while strategically moving out of locations that no longer work.
 

In response, many retailers are shifting more of their resources to their own online operations and away from traditional mall locations. As part of its turnaround efforts, JCPenney, one of a handful of companies in the segment to have a positive 8QTR comparable store sales average (+3.0%), has focused on enhancing its omni-channel experience for customers, creating differentiation among private brands and monetizing on every opportunity to engage with customers.
 

With department stores continuing to struggle with how to attract Millennials, the sensibilities of Generation Z (those born between 1996 and 2010) indicate that they are likely to bypass this traditional format as well. Gen Z’s devotion to digital and video communication and desire for intimate experiences doesn’t bode well for department stores, whose business model relies on appealing to a broad range of consumers, according to RetailingToday. With this in mind, department stores continue investing in technology to enhance the in-store shopping experience by connecting customers with shopping assistance through their smartphones.
 

Consequently, to enhance shoppers’ ability to navigate its stores and create a favorable shopping experience, Macy’s, the largest department store chain in the U.S., is testing Macy’s On Call, a mobile web tool that connects customers with a platform powered by artificial intelligence. The tool, which combines IBM Watson cognitive technology with a location-based intelligent engagement platform from Satisfi, is being piloted at ten Macy’s locations nationwide. It allows customers to ask questions and conduct searches from their smartphones and quickly receive customized responses. Beyond helping people navigate its stores, Macy’s On Call gathers the most popular searches for products, departments, brands, and services to learn what resonates most with customers. The pilot program, which is also available in Spanish at select locations, will run through late fall 2016.
 

As the e-commerce channel continues to grow in popularity and accessibility, understanding the percentage of total revenue that online sales represent, in addition to analyzing the costs associated with running a company’s online channel, can be a key component of an inventory appraisal. For retailers with a growing online component, working with an appraiser with experience in the segment helps lenders understand the impact that utilizing the ecommerce channel can have on net recovery values.
 

The rise of discount: Discount stores like T.J. Maxx have also gained ground (+4.9% 8QTR comparable store sales average), while wallet-friendly fashion brands such as Forever 21 and H&M have cropped up in shopping malls. A dramatic increase in the overall square footage of outlets, along with a trend to locate those outlets closer to traditional urban markets, has taken a toll on traditional department stores. The evolution of new discount fashion retailers and the erosion of market share of retailers on the low- and high-end has been damaging. Department stores have jumped on this trend, opening their own discount stores to attract these buyers. Macy’s launched its “Macy’s Backstage” locations in fall 2015 to sell discounted merchandise. Now boasting a total of 22 locations, the new concept stores stock downflow merchandise from Macy’s full-line stores, including apparel, home goods, and jewelry, at discounts ranging from 20 to 80 percent. Similarly, in 2015, Kohl’s began piloting it’s Off/Aisle concept offering deeply discounted merchandise. There are now three locations nationwide.
 

Given the complexity in the industry, partnering with an appraiser with extensive experience in appraising and disposing of department store assets, who understands these various disposition channels firsthand, remains a critical component of asset-based lenders’ portfolio management.
 

Expanded offerings hope to drive turnaround: Department stores must also invest in improving the in-store experience and expanding brand partnerships to differentiate themselves. These types of customer-focused upgrades have proven successful as evidenced by JCPenney, which has enjoyed a bright spot amidst its struggles in recent years by integrating beauty retailer Sephora into its stores. In 2014, JCPenney outlined a three-year recovery plan to increase sales by $2 billion by the end of 2017; moves to increase sales include upgrading salons with In Style magazine, expanding plus-size brands in the women’s department, and a men’s suit line from NFL Hall of Famer Michael Strahan. The company also has a loyalty program to help it regain customer spending.
 

In another example, Macy’s launched an Apple shop at its flagship Herald Square store in October 2016, making it the first U.S. department store with a shop-in-shop devoted to the brand. Staffed by Apple associates, the shop is located in a prime area on the main floor in the heart of the busy cosmetics and fragrance area. The partnership comes as Macy’s is collaborating with other brands to give “mall-like” convenience and wider access to brands within its stores. Macy’s and Luxottica Group have a partnership to open LensCrafters optical shops in up to 500 stores over the next three years. This effort builds on its collaboration with the eyewear conglomerate’s Sunglass Hut brand that has led to Sunglass shops in nearly 700 Macy’s locations.
 

Given the ongoing popularity of owned and consigned concept shops across all types of inventory within major department stores, partnering with an appraiser with extensive experience in understanding and modeling branded partnership inventory recovery and sales capacity scenarios should be considered as a component of asset-based lenders’ portfolio management in the space.