The Day Ahead: Pieces of the Retail Puzzle

 | Aug 01, 2013 | 8:00 AM EDT
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I tend to shy away from my background in covering the retail sector. I suppose it's "Child Actor's Syndrome", as you want to try mightily to avoid being typecast.

I could do other things (such as wicked quick post FOMC statement analysis), and enjoy ripping apart an industrial financial statement or 50! In addition, I have pretty much seen it all in terms of retail stores.

I have seen the chain of events that led to the demise of Circuit City to a Systemax (SYX) buying the rights to use Circuit City's name on a website. And I have seen Sketchers (SKX) suddenly become one of the hottest stock plays in the consumer discretionary sector once again (now on display). Hence, it takes a bit more news juice for these old bones to get excited on retail, but they did awaken when a story broke on J.C. Penney (JCP) Wednesday.

Anytime a retailer is mentioned as having troubles with financer CIT and subsequently, its vendor base, it's usually not good news. In fact, that is a rule of thumb to keep in mind forever, as it pertains to dissecting potential retail sector investments.

There was a massive uprising in speculation on J.C. Penney immediately following the news break. That was natural to expect given J.C. Penney's precarious financial position (despite a recent slug of Goldman financing) and people on the Street rooting for it to go under due to Bill Ackman's continued long exposure. Lost in the rush to obtain clicks, however, is the sequence of events that the market conjures up in its brain on news of this type arising.

Here is how to piece this puzzle together and remember, this outline will hold true in most instances for retailers experiencing fundamental problems.

  1. Past 12-months of operating performance (three to follow: same-store sales; gross margins; free cash flow) are materially worse than the company's historical norm in peak demand periods and relative to comparable peers.
  2. Outside forms of financing are sought, loan commitments are re-done, and assets are sold (non-core or core, for example, land). A management team is attempting to maintain vendor and stock market confidence.
  3. If the company's operating performance fails to improve in one to two quarters post liquidity injection, a CIT will step in and make it costlier for a vendor to do business with the retailer. This is done to properly account for the retailer's increased insolvency risk. Disregard murmurs that the company could deal directly with large vendors to find operational breathing room. A large vendor is still vendor, and carries the same concerns as the smaller vendors (such as will it get paid for supplying merchandise to the retailer).
  4. The vendor base may so choose to not ship product to the retailer or it will, but in limited quantities.
  5. The retailer will lose market share during peak demand periods, crushing efforts to remain solvent.
  6. The retailer will be forced into some form of major court driven re-organization. Stock price plummets.


Here is another life lesson: The initial move in the markets in response to a FOMC statement is not true. It is emotional as the market is trading on those quick, buzzy headlines. Want to know why the market sold off?  It's simple.

  • The Fed downgraded its assessment of the economy and set the stage for September taper. Eeek!
  • The Fed, in not so many words, said it's comfortable with disinflation. Eeek!
  • The Fed has waved a finger, a middle one, to the Treasury market. In noting mortgage rates have risen "somewhat" the Fed said: "Get over it, ladies and gents, we can handle yields north of the dreaded 2.5%." Eeek!

What I am Watching

  • Homebuilders -- If the Fed has really sown the seeds for a September taper, these stocks will continue to be pressured.
  • Sears -- Because if a CIT lurks on J.C. Penney, it has to be lurking on Sears (SHLD) Shares of Sears,  as I have said recently, are signaling very bad news ahead.

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