Tuesday, August 23, 2011

August Commentary: With Borders Gone, Who's Next?

Right out of the box, we'll tell you that we haven't the foggiest. I suppose we have a number of names that make the Watch List, but no particular retailer stands out. While we continue to see fallout from some furniture operators and other independents, there is no significant chain that jumps out at us regarding a looming bankruptcy.


Rite Aid has been a concern, but comp store sales at the pharmacy chain have recently turned positive. Rite Aid has not shown a recent profit, but as it continues to pare unprofitable stores count, chances that the company will hang around for a while continue to improve. The long term outlook, however, may not be so promising.

We continue to see other chains downsizing, particularly those most impacted by E-commerce. Online sales may ultimately play a villainous role in determining from which retail category the next victim may hail. A recent report from ComScore indicated that online US retail spending was up 14% in Q2. We have to go back two years to Q3 2009 to find the last quarter that wasn't a double digit gain, a far cry from retail sales trends overall. In fact, ComScore reported that nearly $1 of every $10 in discretionary spending is done online, although this factoid reflects items such as event tickets and travel.

E-commerce (online) sales as a percent of total non-auto retail are approximately 5.6% but if we add in mail order sales the ratio jumps to 8.9%. E-commerce sales have grown more than sevenfold since the beginning of 2000 when online sales were not much more than a mere nuisance to brick and mortar retailers. To help put it into perspective, during the12-month period through Q1 2011, E-commerce sales were $173.4 billion, the rough equivalent of Target, Best Buy, Macy's, Kohl's, JCPenney, and Staples aggregate total sales.

In its report, ComScore goes on to say that the best performing online categories have been consumer electronics, computer hardware, and computer software with each growing by at least 15% since last year. That doesn't bode well for retailers selling these categories but many have indicated that stores will be downsized appropriately and in some cases remerchandised.

Best Buy, for example, has experienced significant declines in sales of consumer electronics (TVs, cameras, camcorders, etc.) and entertainment (video gaming hardware and software) products. Combined, the company has seen these categories decline from 60% to 51% of total sales since FY 2006 as online sales and digital content take a toll. Although mobile phone and mobile computing sales have offset some of the impact, it certainly hasn't offset the floor space required to sell those products. Consequently, Best Buy has decreased its prototypical size from 45,000 to 36,000 square feet while it continues to grow its Best Buy Mobile division both in-store and geographically. In existing stores, excess space will be subleased.

Staples is another retailer which is in the midst of downsizing. Computers and office machines currently account for only 46% of sales after generating as much as 52% of the revenue as recently as 2006. With 500 leases expiring over the next three years, and on the heels of disappointing sales, Staples going-forward plan is to open smaller stores.

Walmart announced a few months ago that it also was reducing electronics floor space in its stores and reallocating square footage to apparel. Additionally, this retailer is developing smaller concepts such as Walmart Market, prototypically 42,000 square feet, and Walmart Express, which runs about 15,000 square feet. Both divisions will take advantage of urban markets where real estate is at a premium and where it can go head to head with grocery and dollar stores.

Several other retails, including Sears, Office Depot, Target, and LL Bean have announced smaller store plans. Sears will sublease excess space where store productivity warrants it. Office Depot is facing similar obstacles to Staples. Target is moving into urban markets with City Target with stores ranging from 60,000 square feet to100,000 square feet. LL Bean just announced that it will be opening its second 14,000 square foot store in November, much smaller that the 30,000 square foot units it had been opening during the past several years. The company is planning to add 14 stores between now and 2014 and all are expected to be the smaller prototype.

The trend toward smaller stores is clearly a sign of the times. Consumer belt buckles have tightened and online retailing continues to make inroads on brick and mortar space. It's becoming more apparent every day that the retail industry has entered a new era. We all better adapt!

Bob Sheehan, Vice President of Research
BSheehan@KeyPointPartners.com

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