This Trade Is One of the Last Profitable Plays in the Dying Retail Sector

Everyone shops – but thanks to the Internet, where and how we shop has changed in ways that none of us ever imagined.

And our shopping habits aren’t the only thing that’s changed.

For one, the retail landscape is already littered with the corpses of recently deceased companies, including…

  • Sports Authority
  • Vestis Retail Group (operator of Sports Chalet and Eastern Mountain Sports)
  • Aeropostale
  • Linens ‘n Things
  • PacSun
  • American Apparel
  • RadioShack
  • WetSeal
  • Eddie Bauer

The list goes on… in fact, I’ve got my eye on dozens and dozens of other companies that are positioned to fail.

The truth is, there’s a ton of money to be made on retail stocks – if you know what you’re doing.

But before you go shorting retailers left and right, there are a few things you should know. While retail is indeed a dying sector, it’s going to be a long, slow trip to the grave – not all retailers are going under, and many more are going to use every trick in the book to stay afloat as long as possible.

Here’s what’s already changed, the massive shift that’s coming next, and the one trade you can make to profit…

The Death of Retail Has Been Greatly Understated

If you’ve heard the death threats shouted at retailers, you have an idea of what I’m talking about. Lots of them are in big trouble.

The list of retailers who’ve filed for bankruptcy is a long one – the handful of companies I mentioned above is just the beginning of the slaughter.

But while the retail sector as a whole is in a world of hurt right now, investing is not as easy as you think.

Retail vs. the S&P
Need more proof that retail is headed in the wrong direction? Look no further than the S&P 500.

Since the beginning of the year, the world’s most-watched market index has tacked on 3.5% so far, rising from 2257.83 to 2338.17.


GSPC Chart


Meanwhile, the SPDR S&P Retail ETF (NYSEArca:XRT) has lost -6.06% over the same period:

XRT Chart


This trend will not only continue – it’s about to get much worse.

Not all retailers that look like they’re headed for oblivion will die off for good. Some will seek bankruptcy and disappear, and some will come back to life, rising like a phoenix from the ashes.

Then there are the retailers who’ve declared bankruptcy (some more than once), and are still around. Many are struggling mightily and will likely declare BK again before disappearing for good. Surprisingly, some down-on-their-knees retailers will turn around and be good short-term bets to ride higher.

In short, you have to be careful where you put your money and how you’re positioned

I’m going to show you the best way to position yourself for profits right now. But before I do, I want you to understand why – because it’s an essential part of our strategy (as you’ll see in a moment).

First, looking at the retail sector today requires looking at all retailers through the lens of Internet accessibility.

It’s cheaper to do business across the Web than it is to own bricks-and-mortar stores – that’s obvious. What’s less obvious to investors is how retailers look at bricks-and-mortar stores, even in the Internet age.

Physical stores create brand awareness, which is one of the principal reasons retailers have traditionally opened more stores. If one store sets up in a popular mall or shopping area, it was almost a necessity that competing retailers locate a space nearby.

A lot of shoppers still enjoy going out to shop, handling the merchandise, and trying on the clothes. They also appreciate the interaction with salespeople who help them distinguish between options when there are lots of competing products available.

Shopping still has the legacy of being a fun day out, an event to enjoy.

But the ease of Internet shopping, the cheaper prices, the ability to comparison shop, and the free shipping have made heading to your favorite mall or retail shopping center look like a waste of time and money.

For retailers with bricks-and-mortar stores, a single metric represents the difference between overwhelming success and crushing failure.

Most Retailers Are Failing Basic Math

While total sales, revenues and net profits are obviously important, bricks-and-mortar retailers have to view their sales through the cost of their stores on a sales per square foot basis

It’s basic math for big shopkeepers, and that math is killing them.

According to Green Street Advisors, a premier real estate research firm, sales at the nation’s department stores averaged $165 per square foot in 2006. As of spring 2016, that number was down 24% to $124… and it’s been falling steadily since then.

Meanwhile, those same department stores only reduced their physical footprint by 7% over the decade.

Green Street estimated last year that big department stores occupy about two-thirds of all mall anchor space. Without losing any more sales to the Internet, big department stores would have to cut 1/5 of their current stores just to maintain 2016 sales per square foot numbers. To get back to those lofty 2006 numbers, the cuts would be even deeper (see the chart below)





The loss of those stores, which is inevitable, will decimate malls and other retailers who rely on these anchors to drive foot traffic.
Sure, a lot of retailers are ramping up ecommerce sites and increasing ecommerce sales. But those sales pale in comparison to their revenues from store sales, and the prospect of replacing store sales with an equal amount of Web sales is highly unlikely.

In terms of square foot per capita, the United States has an estimated 48 square feet of retail space for each person in the country. That’s twice as much as the UK, the next largest retail per capita country in the world.

The knock on retailers who own or lease real estate is that they’re competing against ecommerce companies who aren’t burdened with bricks-and-mortar overhead, store sales, or management personnel.

Then there’s the decline of America’s middle class, the sector of the population who made malls and strip centers across the country popular. Besides the cost of gas to get to shopping areas (opposed to the free shipping offers across Internet “e-tailers”), most millennials don’t own cars and are increasingly moving to urban cities away from the suburbs, where malls were once a place to “hang out.”

As if competitors like Amazon aren’t enough to deal with, traditional retailers are also wrestling with “fast fashion” across the Internet, as well as bricks-and-mortar fast fashion chains like H&M.

Retail specialty shops aren’t so special anymore. Department stores sell most of the brands shoppers can find online – where they can be found cheaper and sometimes without having to pay tax or shipping.

These trends are killing traditional shopping malls, whose anchor stores are usually big department stores.

Giant anchor stores usually pay about one third what mall shops pay in rent, as they drive the foot traffic specialty shops expect through malls and shopping centers. Yet they are still losing a lot of money, and losing their stores right and left.

Several household-name anchor department stores are closing big stores across the country. Macy’s Inc. (NYSE:M) said it’s closing more than 100 stores and J.C. Penney Co. Inc. (NYSE:JCP) is expected to as well. Sears Holdings Corp.’s (NASDAQ:SHLD) Sears and Kmart stores are folding up tents across America and have been for years now. Dillard’s Inc. (NYSE:DDS) is probably on the verge of closing altogether.

Consulting firm Bain & Co. recently reported that falling sales at bricks-and-mortar stores aren’t being replaced by Internet sales. In fact, dwindling bricks-and-mortar stores are dragging down ecommerce sales by about 20%. Some of the lost sales are the result of diminished brand awareness or prestige, as shuttered stores send a negative message to shoppers.

The Difference between Chapter 7 and Chapter 11
The first thing to understand is there are different bankruptcy filings companies generally employ.

In a Chapter 11 filing, the principal debtor (known as debtor in possession) or a trustee, is empowered to reorganize the company.

Under the protection of the bankruptcy court, the debtor in possession or trustee can refinance loans. This gives new lenders first priority on earnings, the ability to reject and cancel contracts, and shelter the company from some types of litigation through an automatic stay, which prevents creditors from any collection attempts or activities against the debtor in possession.

Reorganizing under Chapter 11, on the other hand, is an opportunity to change up management, close stores, lay off employees, rework loans, slim down, and try to reflate the brand and sales.

Filing Chapter 7 is throwing in the towel.

It means the company ceases operations; however, in unusual circumstances a Chapter 7 trustee can continue some operations. But, more often than not, the trustee oversees the liquidation of the company’s assets, and proceeds are used to pay off creditors.

Retailers filing Chapter 7 are going out of business, usually for good. If you see what you think is that familiar company again, it’s usually because a buyer of their name and other assets of the dead company may start up another company they want associated with a legacy brand.

The End of an Era

According to the Centre for Retail Research, online sales in 2015 in the U.S. reached $347.25 billion.

ComScore, an online metrics firm that captures online sales data of everything and tracks online habits, reported that in 2015 online sales of apparel and accessories reached $51.5 billion while online sales of personal computers, tablets and other computer hardware equipment totaled $51.1 billion. After ten straight years of commanding the largest sector of online sales, apparel took that throne from computers, and it looks like it will stay that way for good.

As online sales in general increase, percentage of total online sales for apparel and accessories, items traditionally purchased in stand-alone stores and shopping centers across America, are expected to grow at about 19% annually. That’s an increasing slice of a rapidly growing pie.

And by 2018, according to Statista, that slice could be worth a whopping $86 billion.

Online sales in the U.S. totaled $399.53 billion in 2016, up 14.4% from 2015. Sales in 2017 are expected to rise 14.9% to $459.07 billion in 2017, according to the Centre for Retail Research. Looking ahead, they’re slated to grow another 15.4% to in 2018 to at least $529 billion.

ComScore’s research indicates that apparel shoppers started feeling it was “less risky to shop for clothes online.”

One big concern was returning merchandise. “Return policies got much better a few years ago, and that has lowered the friction to people buying in the apparel category,” said Andrew Lipsman, ComScore’s vice president of marketing and insights.

Besides the ease of returning merchandise, online shoppers have increasingly been offered free returns, and often free shipping, depending on the dollar volume of an order or the shopper’s online buying history.

The great purveyor of “free shipping” and “two-day delivery” is, of course, Amazon.

Becoming an Amazon Prime member for only $99 a year gives Amazon shoppers free two-day delivery. That’s on top of the other services Prime members enjoy like free streaming of videos and music, as well as other perks.

According to Consumer Intelligence Research Partners, nearly one half of U.S. households are Prime subscribers. Amazon’s Prime offerings essentially force competitors to offer similar shipping deals or lose business to the undisputed king of e-commerce.




Another surprising trend in the online apparel sales universe is the growing number of people who buy through their smartphones.

Again, ComScore notes that because of their comfort shopping online for apparel and accessories, shoppers are doing less online research than they browse on laptops and tablets, and more frequent buying on smartphones.

That’s another nail in the bricks-and-mortar retailers’ coffin; online smartphone sales are seeing explosive growth across all merchandise categories, but especially apparel.

Already in 2017, we’ve seen 14 bricks-and-mortar retailers try and reorganize, declare bankruptcy, or liquidate themselves. That’s almost as many as the total number of distressed companies that broke down last year, when there were 16 companies knocked to the ground.

That kind of carnage makes 50 potential bankruptcies in the next 12 to 24 months very possible, if not probable.

Don’t Fall Into This Trap

Almost every traditional bricks-and-mortar retailer’s stock – and, believe me, there are a lot of them listed on U.S. exchanges – has seen its stock get cut to pieces.

A lot of those stocks look cheap now. They’re even being looked at as value propositions by some analysts.

Some have been getting bid up lately, giving them the occasional big up-moves that make financial news headlines.

Don’t buy it. It’s a trap.

What’s really happening in a lot of cases is that these stocks have been sold short by smart investors who saw the demise of bricks-and-mortar retailers coming. They are occasionally taking profits by buying back the shares they shorted as rallying markets draw in investors looking for bargains and so-called value stocks.

So many hedge funds and traders are short these stocks, the thinking on the Street is that the whole “short retail” trade is overdone.

“The short feels crowded to us,” said Matthew Weinstein, principal at hedge fund Axonic Capital. “If these defaults start happening soon, the short will work, but if the defaults do not occur quickly, the first guy out could drive the market meaningfully higher.”

And that’s exactly what’s happening.

Moves upward in these left-for-dead stocks are merely shorts covering their positions. When there are a lot of shorts in a stock and the stock starts getting bid up (either by hopeful bargain hunters or clever traders whose play is to buy enough shares to squeeze shorts into buying, driving the stock higher), the unexpected up-move attracts interest.

Don’t be duped, these plays are fool’s gold.

Most of these stocks are headed back down after this rally peters out, whenever that may be.

The smart way to play these dinosaurs is to play the same games the shorts are playing and the same game the pros who squeeze the shorts are playing… at the same time.

That’s how we play them in my elite trading service. You should do the same.

While it makes sense to short a lot of these stocks, it’s sometimes better to buy puts on some of them. The returns on successfully timed put options purchases can be staggering.

Depending on the stock and our mathematical expectation for a company to declare bankruptcy based on metrics like its debt, what’s left on its outstanding credit facilities, its cash flow and sales, we might buy puts that expire a year out. Or we might buy cheaper put options that expire only a few months out, take profits on those when the stock goes down enough, and buy more puts further out. You can do that again and again, as long as the company and the stock are dying slow deaths.

In short: buy puts on the stocks with too much debt, slowing sales, and little time left before they’ll be unable to meet their monthly interest and principal payments.

You can also buy some short-term, near month call options on some of these deadbeat retailers to profit from the up-moves they enjoy when hard driving hedge funds squeeze scared shorts into buying back their shorts and driving up prices.

Finding the right stocks to buy puts on and the handful worth buying calls on is the trick.

One Stock to Target Right Away

The bull market since the 2016 election has taken Pier 1 Imports Inc. (NYSE:PIR) dramatically higher. They’ve gone from trading around $4 in November to as high as $9.67 in December.

But, oops, holiday sales were down, and the stock’s been on the downslide since. Oh, and the stock’s dramatic December 15th jump from a close of $6.48 the day before to an intraday high the next day of $9.14 (a 41% pop)… That’s EXACTLY what a short-covering rally looks like.

The stock’s been carrying a huge short position for a long time now. Right now, it’s close to 19% of the outstanding float. That’s a big number, and means PIR’s prone to pops.

So, what happened next? Oh, the pig collapsed. It’s around $6.75 now.

In 2016, Pier 1’s earnings growth was a NEGATIVE 19.57%. Its revenue growth wasn’t a growth either, it was a NEGATIVE 3.37%.

As far as those net sales in the holiday season, not so good. They were actually DOWN 2.6%.

But the company’s fiscal year isn’t the same as the calendar year. PIR’s fiscal year ended on February 25, 2017. So, how did they do in the fiscal year?

Lousy.

Full fiscal year net sales were down 3.4% and comp sales were down 1%. PIR’s comp, or comparable sales, are based on same stores being measured from quarter to quarter or year to year, are actually misleading, which is something I hate.

The company’s got about 1000 stores and is paring them back, but not nearly fast enough. They can’t survive on dramatically falling same-store sales that are being masked by online sales being added into them. The company shaved around 3% of their stores last fiscal year. That’s a deck chair off the old Titanic, folks.

EBITDA for the latest full fiscal year was $110.5 million, vs. $125.2 million a year prior. That’s an almost 12% drop.

As far as their inventory, not so good there either. Inventories fell a whopping 1%. Seriously? After closing 3% of their stores they only pared inventory 1%?

Pier 1 Imports has some big problems.

Store count is one. Too much inventory in another. Falling comp sales is another. And those are the mechanical issues.

The existential threat facing Pier 1 is the Internet. There’s practically nothing they sell that can’t be found elsewhere across the Internet, or simply on Amazon. PIR had a neat niche, but that’s long gone.

There’s only one way PIR can survive, that’s becoming an online retailer. They could try to get there, but in the process the cost of closing all those stores, selling real estate they own, which isn’t much, and getting out of long-term leases, is going to hit their EBITDA and stock.

What hopeful Pier 1 investors want is for the shorts in the stock to get squeezed out and for their buying to take the stock higher. That will happen from time to time.

But if you know how to read a chart, you know that every short-covering pop was shortly thereafter visited by a big down day on even bigger volume than on up days.

That’s not good for the bulls.

There’s nothing good on the horizon for PIR. That’s why we’re jumping on it now.

The stock’s going to test its 52-week lows ($3.74) if the market run ends and we see an across the board correction. This pig will get dirty in a hurry.

I recommend that you buy PIR January 19, 2018 $3.00 puts (PIR180119P00003000).

This position gives you a TON of time to allow this trade to develop. If the stock starts getting hit hard, I recommend taking profits all the way down.

It’s going to be an ugly few years for retailers, but highly profitable for traders and investors who understand how retail really works, how the debt has to be accounted for, and the games retailers play with their reported sales numbers.

I’ll be covering all that right here in Wall Street Insights & Indictments… and I’ll be naming names.

Sincerely,

Michael
Shah