Markets & Economy

Sears and the Evolution of Retail

On Monday, Sears Holdings announced it was filing for chapter 11 bankruptcy. The storied brand has struggled for years, and has failed to turn a profit since 2010.

Sears intends to restructure its assets under chapter 11, so it is possible that some stores will remain open. (Recently shuttered also-rans Toys “R” Us and RadioShack also planned to restructure, but wound up liquidating instead.) Sears reportedly hopes to stay open until Christmas while trying to find a buyer in bankruptcy.

A Challenging Reality

We first wrote about retail closures this year when we discussed the “bricks to clicks” trend. “Bricks to clicks” describes the trend toward buying online, which has increasingly favored e-commerce over physical retail locations. Since then, the bleeding has continued for brick and mortar retailers.

More than 3,800 stores are expected to close in the US in 2018 alone, and there is still a long way left to fall. The US currently has enough retail shopping space for every man, woman, and child to claim almost 24 square feet as his or her own.

It is important to note that the closures are materializing during a time of relative economic comfort in the US. The economy is generally strong and consumer sentiment is robust. Should we head into a recession or downturn, the situation in retail could take a turn for the worst.

Should we head into a recession or downturn, the situation in retail could take a turn for the worst.

This reality, coupled with an economy we view as later-cycle, has caused us to be overall conservative with our retail holdings. Still, there are a few names we find attractive right now.

Bright Spots in Retail

In the wake of the Sears closings, some direct competitors (J.C. Penney, Kohl’s, etc.) may see a small bump, but ultimately there are many places to buy apparel and appliances. Instead, we see potential opportunities in specialty retailers such as Dick’s and Ulta. They offer a differentiated experience to consumers, and also stand to benefit as more department stores close.

Dick’s has strong and often exclusive brand partnerships, which allows them to provide customers with a wider selection of products. Dick’s also has a healthy e-commerce operation that accounts for 11% of sales. Sporting goods competitors like Sports Authority and Gander Mountain have closed, and we believe Dick’s has the scale and strength to be the “last man standing” in the space.

Ulta is the largest specialty beauty retailer in the US, offering both mass and prestige products in an environment that encourages customers to try new products. We believe it will be harder for online shopping to gain traction in the beauty and personal care space, since many shoppers prefer to test makeup and fragrances before buying.

Other Potential Opportunities

While shifting consumer preferences are leading to store closures, they are helping create valuable investment opportunities in other areas. Obviously, e-commerce companies like Amazon are beneficiaries of this change, but there are also other, less obvious winners.

Industrial real estate is one such area. An e-commerce transaction requires an estimated three times as much warehouse space as a traditional brick and mortar sale. More warehouse space will be required to address the need for greater product selection, the increased shipment of parcels instead of pallets, and customer returns.

Sears will almost certainly not be the last casualty in the so-called “retail apocalypse.” At Manning & Napier, we are always watching not only the headlines but also the underlying trends driving events like this one. Our active management style helps to minimize risk while finding pockets of opportunity.

The data presented is for informational purposes only. It is not to be considered a specific stock recommendation.