Retails were hit hard in March, as some faced bankruptcy fears, and others went through bankruptcy/restructuring proceedings (J. Crew, Neiman Marcus, etc.). Retail sales fell off a cliff in April, and saw a surprisingly sharp rebound in May due to the reopening of the country at different stages throughout the month. June has proceeded relatively scare-free until now. And what’s particularly troublesome is that while retailers in clothing/apparel are still down significantly (>50%), the SPDR S&P Retail ETF (XRT) had already hit a V recovery, with a June 8 close as high as closes in January and February.
As June is coming to a close, we’re still seeing volatility within the markets in part due to fear about rising cases. While the narrative last month seemed to be much more lax in regards to a possible second wave, we might already be seeing the start of a second wave. As nearly all states are facing rising coronavirus cases, the outlook for retail could be shifting negatively again – either targeted locations will continue to close for now, as has been the case, or a broader set of store closures could come into effect. States also have been making decisions about reopening progress, which could leave closure decisions out of company’s hands.
Florida and Texas have reversed reopening measures and Georgia saw a record increase reported on Sunday ahead of the July 1 reopening measure announcement date. Former CDC Director Tom Frieden commented that “as a doctor, a scientist, an epidemiologist, I can tell you with 100% certainty that in most states where you’re seeing an increase, it is a real increase. It is not more tests; it is more spread of the virus,” when asked about the increase in cases.
Regarding closures, Apple (AAPL) recently announced more store closures, adding to the tally that it had closed the week prior. Apple closed 11 stores in Arizona, Florida and the Carolinas on June 19, added 14 closures in Florida and 7 in Texas on June 25, bringing the total reclosed in the past week and a half up to 32, over 10% of Apple’s 271 U.S. locations. These newly reinstated closures could be a warning sign for general retailers.
Yet it’s not Apple that needs to be worried about. As we are now facing spikes in cases, Apple looks to be one of the first to step ahead and re-close stores. Apple doesn’t need to rely on storefront services and sales to drive revenues; although it could see a secondary adverse effect from closures (depending on the length of the current closures and possibility of closures of the remaining stores across the country), what makes these announcements worrisome is where these stores are located. Not state, but space. It’s the smaller and less prominent retailers that are located in locations and mall fronts alongside those Apple stores that have closed that could see larger adverse effects.
The affected Apple stores are primarily located in high-end malls, typically in more upscale areas and lined with recognizable luxury/semi-luxury brands. Upscale malls like Town Center at Boca Raton, The Galleria Fort Lauderdale, Brickell City Centre in Miami, and Scottsdale Fashion Square, among others, saw their respective Apple stores closed.
Other tenants in these specific malls and those in other nearby malls and retail spaces might start to be faced with similar predicaments concerning store re-closures, specifically those clothing/accessories and (anchor) department stores. Those subcategories of the broader retail industry were some of the hardest-hit during the initial lockdown and closure period, with clothing and accessory stores falling 78.8% in April.
Another spell of closures could spell trouble or even disaster for already impacted clothing and accessory brands (as in the smaller stores – PVH, GES, URBN, AEO, ANF, CPRI to name a few; not LULU or NKE). 12 states have already halted or stepped back in reopening plans, and reimposing social distancing measures like group sizes could easily restrict the number of shoppers that are allowed in on a square foot basis.
But when investing in retail, the sector has a wide range of subsectors, some of which, like e-commerce and discount/bulk warehouses, have done surprisingly well. So when looking at XRT, it’s important to note that, as a broad ETF, it isn’t just allocated towards one subsector of retail; although apparel & accessories and department stores compose 29.89% of the overall sector holdings, the actual breakdown by individual holdings shows how the performance has been skewed towards this V shape shown below, and why it could be particularly vulnerable in July.
None of XRT’s top 10 holdings are in the two beaten-down sectors mentioned before. Top holding Overstock (OSTK) is up over 950% since mid-March; other top holdings Etsy (ETSY), Camping World (CWH) and Wayfair (W) are up over 200%, 500% and 700%, respectively, since then. These powerful rallies could be the main driver of the V in XRT as the top 10 holdings compose 15.1% of the overall holdings (3 of the other top 10 holdings are up over 100% since March).
So we have two sides to the XRT story – one that its top holdings have been not just some of the best performers of the retail industry, but some of the best of the whole market since mid-May, and the other that its holdings in the clothing/apparel and accessories stocks are smaller (SIG, GES, ANF, LB, DBI, JWN, URBN, AEO). These names have struggled and could continue to do so, while the online, grocery and more defensive retailers have shone.
Now while most of the names in clothing and accessories held by XRT seem to be in decent financial shape – i.e. not overly laden with debt – some appear to be struggling. In particular, Capri Holdings, owner of Michael Kors, Versace and Jimmy Choo, is technically insolvent based on its last report – as its current liabilities popped up to $2.3 billion with current assets still below $1.8 billion. Then there’s holding L Brands (LB) and Sally Beauty (SBH) which have pretty consistently run a shareholder deficit. Although that had been the case from 2010 onwards, the retail environment had not faced a rapid negative catalyst that could punish companies with weak balance sheets.
For an ETF, having a holding go under, or potentially run close to needing bankruptcy protection – such as Nordstrom (JWN), another name who is borderline insolvent and could be in a similar trap to its close competitor Neiman Marcus – could drag value lower. As we could be facing a second round of closures, this discrepancy does not bode too well. Approximately 30% of XRT’s holdings are in the apparel & accessories and department store space, and the possibility of closures following Apple is not a positive signal for XRT, as those names could face another sell-off: even though some of the names mentioned before in apparel and accessories are still down YTD, they have rallied off March lows and could have more room to fall, whereas the top holdings are up significantly YTD.
Yet all hope is not lost. We could remain in a period of targeted closures or stepbacks in reopening measures, as opposed to a secondary nationwide lockdown. If this is the case, stores could continue to stay open as long as they are not in affected regions or forced to close through state rules. Even though the narrative pervaded throughout this article focuses on stores closing again, that might not happen. Previous quarter earnings from most clothing and apparel names, which faced two wild, record-breaking months of sales activity, were below or far below the mark. Upcoming quarter estimates are still very low, and for some stores, could provide beats, and quicker perceptions of a return to profits, therefore driving both those companies and XRT higher. And should clothing and apparel names start to rally, XRT could even be pushed up to new highs, as many of its components in e-commerce have soared significantly since before the selloff began.
To conclude, it could just be that Apple is ahead of the curve here when it comes to re-closures of stores, or it could be that Apple is playing it too safe, and we won’t need other re-closures. But the rise in coronavirus cases nationwide combined with a dozen states now pausing reopening could mean that we might need a re-implementation of slightly stricter measures for a short period of time. What remains still is uncertainty – how much longer will case numbers rise, what states could be the next epicenter after Florida and Texas, will reopening pause in more states – and that uncertainty translated into retail – what stores will need to temporarily reclose, what stores can handle that on a liquidity basis, what stores could be pushed closer or even into bankruptcy if another period of closures in clothing and apparel stocks hits.
Disclosure: I am/we are long GES. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.