Shopping around – opportunities in retail

If you look at the share prices of conventional retailers today, you’d be forgiven for thinking that the high street is on its last legs. Recent store closures and bankruptcies have added to pessimism. Meanwhile, the eye-watering valuations of online retailers reflect a very rosy future indeed. The stockmarket has delivered its verdict: Amazon will take over the world, leaving a retail apocalypse in its wake.

As Amazon creeps towards a $1tn valuation, its shares trade on over 100 times this year’s earnings. That leaves little room for any disappointment. In contrast, out of favour Marks & Spencer and Macy’s, both of which are undergoing major transformations, are on a mere 12 times and 10 times, respectively*.

So does this gulf in valuations really point to the extinction of the high street? We believe it’s misguided to assume that online will be the only way to shop. Online transactions are here to stay, but investors shouldn’t underestimate the staying power of shops. A shopping trip is a major leisure activity for a great number of people – not just a necessity, but a social activity, even a hobby. The convenience of clicks can’t compete with that.

Instead, the market’s disdain for conventional retailers could be a buying signal for contrarian investors. The high street’s survival of the fittest has created some high-profile victims. When the status quo is challenged, companies with credible plans to reinvent themselves tend to be the ones to survive and thrive.

Many bricks-and-mortar retailers are meeting the e-commerce challenge head on, by creating multi-channel offerings with mobile apps and ‘click and collect’. Some are also adding other leisure services to their sites, increasing footfall and encouraging spending. And many have powerful brands that e-commerce has yet to rival. Marks & Spencer provides a good example.

Revivals in Marks and Spencer’s fortunes have been heralded before, but we believe that this time really is different. Led by veteran retailer Steve Rowe and turnaround specialist Archie Norman, the company is shedding excess stores, revitalising product lines and improving its pricing strategy. Its food division is still very popular and its investments in IT and infrastructure are creating a robust multi-channel offering. If successful, this should boost earnings and improve margins.

One of our best-performing stocks is Macy’s, which operates the US’s largest chain of department stores. Given the challenges of e-commerce, the company’s shares have been deeply out of favour. However, the company recently announced better-than-expected sales and a more promising outlook. Strong consumer spending, improvements in its bricks-and-mortar business and more ‘disciplined’ discounting are helping the company to positively surprise investors. Macy’s has also been cutting costs and store space, while driving more value from its property holdings. Around 14% of Macy’s shares are currently on loan to short sellers, who are betting that they will fall in value. Such ‘short interest’ is a sure sign that a stock is resolutely out of favour. For contrarian investors like us, it can point to exactly the sort of overlooked opportunities that we prefer.

We see these and many other retailers as ‘ugly ducklings’ – unloved shares that most investors shun. Although they have been under pressure from online competitors, they have considerable potential to defy the market’s pessimistic expectations and turn their circumstances around. And while we wait for our ugly ducklings to become swans, most – like Macy’s and M&S – offer higher-than-average dividend yields. We believe that the depressed shares of high-street operators conceal compelling opportunities. Smart investors should look out for high street bargains.

*As at 22 August 2018; data source: Bloomberg.

Please remember that past performance may not be repeated and is not a guide for future performance. The value of shares and the income from them can go down as well as up as a result of market and currency fluctuations. You may not get back the amount you invest.

The Scottish Investment Trust PLC has a long-term policy of borrowing money to invest in equities in the expectation that this will improve returns for shareholders. However, should markets fall these borrowings would magnify any losses on these investments. This may mean you get back nothing at all.