Retail Pain Ripples Outward

 | Mar 23, 2017 | 2:00 PM EDT
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amzn

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ups

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shld

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There is little question that retailers, especially department stores, are feeling the pain associated with the shift toward digital consumption.

While powering shares like Amazon (AMZN) and United Parcel Service (UPS) , the corresponding headwind continues to vex. As we said when we saw the February retail sales report: "No surprise," given the commentary from the likes of hhgregg (HGG) and J.C. Penney (JCP) , both of which have announced store closings, joining the ranks of Sears (SHLD) , Kohl's (KSS)   and Macy's (M) . Surely winter storm Stella is going to put a crimp in March bricks-and-mortar sales for retailers with heavy exposure to the Northeast, including Lululemon (LULU) , Abercrombie & Fitch (ANF)   and Urban Outfitters (URBN) . What those all have in common is they tend to be mall-based retailers.

It's simply another set of woes for mall REITs like Simon Property Group (SPG) . Recently, Morningstar Credit Ratings analyzed the commercial mortgage-backed-securities (CMBS) debt load on malls with exposure to J.C. Penney, and found that as a collateral tenant, CMBS exposure to J.C. Penney totals $16.43 billion. Remember, J.C. Penney is closing 140-plus stores and that CMBS debt load doesn't take into account other anchor store closings from Macy's, Sears or others.

Over the last few days, a few new data points bolstered our confidence in the underlying thesis for this short position. First, Wells Fargo has turned bearish on retailers, noting that, "increasingly clear that retail is under significant pressure," adding that store traffic remains weak and is likely to get softer this quarter due to the timing of Easter. Worse yet, markdown rates are not only elevated on an annual basis, but also getting sequentially worse. Those remarks were followed by investment firm Cowen sharing that its latest retail channel checks for March came in worse than expected.

Clearly, there is more pressure ahead for bricks-and-mortar retailers. And as they close locations, it causes problems for companies like Simon Property Group.

The real blow for SPG shares came in Sears' 10-K filing in which the company said "substantial doubt exists related to the company's ability to continue as a going concern." We've long known that SHLD was a company struggling to identify itself as our Connected Society investment theme has transformed where and how people shop. The issue for Simon Property Group is Sears is a key anchor tenant across a number of its properties. Paired with store closings from Macy's, J.C. Penney and a growing list of others, we see more pressure ahead on SPG's business model. By the way, this is a great reminder as to how useful company filings, like 10-Ks and 10-Qs, can be.

That pressure now includes prospects, per Bloomberg, that Payless (PSS) is likely to file for bankruptcy next week. As you'll hear Lenore Hawkins and I discuss on our latest Cocktail Investing Podcast, given inroads by Amazon and Zappos in the shoe market, we're somewhat surprised Payless has lasted this long.

The bottom line is investors need to consider the retail pain ripple, which is going to cause problems not just for the retailers themselves, but their landlords as well as those who hold their commercial paper and bank loans.

It's another reminder that it pays to connect the dots when investing and to consider that for every company benefiting from a tailwind, there is a corresponding headwind to be had.

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