As Macy's Slumps, the Smart Money is on Discounters

macy's store building
Spencer Platt / Staff / Getty Images

Right now the retail sector is a case of the haves and the have-nots. After another dismal earnings report Wednesday, it’s clear where Macy’s (M) falls.

A Company in Free-Fall

Let’s review the latest quarterly results from Macy's. The department store slashed its profits and sales expectations by 15-20 percent for the year as same-store sales dropped for the seventh time in 10 quarters. The stock continued its precipitous drop and now sits at $31 a share, a drop of more than 50% in the last year alone.

 

In response, Macy’s announced plans to cut expenses, enhance online and focus more on cosmetics and off-price merchandise.

"We are not counting on the consumer to spend more, so we are working harder to give customers more reasons to buy from us, "said Chairman and CEO Terry Lundgren in a company release.

But will it be enough? Even at its current price analysts are still not sold on Macy’s as a value play: Citigroup lowered its price target to $30 from $40 on Thursday, citing structural issues, and even the charts look disappointing to technical analysts.

“Looking at the technicals, stocks like Macy's, Target (TGT) and Kohls (KSS) have dropped sharply,” says Stephen Kalayjian of The Kalayjian Report. “There might be an oversold bounce, but technically speaking these are stocks I would look to avoid.”

Indeed, Kohl's reported dismal numbers Thursday, with comparable sales declining 4% in the first quarter.

 

Discounters Capitalizing

So, if you’re looking to invest in the retail sector, where should you turn? The biggest winners in retail have been the off-price retailers like TJ Maxx (TJX) and Ross Stores (ROST). With mall traffic dying a slow death, department stores unload their excess inventory to the discounters, who in turn pass along 20-80 percent in savings to the consumer.

The department stores’ loss is discount retailers’ gain.

And lately, that’s more true than ever. If you’ve ever listened to a retail earnings conference call, you know that management is notorious for blaming revenue and comparative sales on the weather. But in the last 6 months the’ve had a legitimate case to complain. An unseasonably warm winter (remember that 70-degree Christmas?) and a chilly spring in the Northeast meant that department stores and single-brand retailers like Gap (GPS) got stuck with winter coats in December and were overloaded with shorts for Spring inventory.

All of that untouched inventory created a promotional nightmare for the department stores that already struggle with less foot traffic. Meanwhile, the off-price retailers were able to negotiate fabulous deals for that merchandise which they passed through to the consumer, leading to even more foot traffic.

The department stores need to find a way to get foot traffic back to the mall and find new areas of growth. Cost-cutting can only go so far, and hinging the value of these companies on their real estate will only take the investment thesis so far. In the meantime, retail investors would be wise to keep their focus on the discounters.

 

Jill Malandrino is the Voice of America's New York Bureau, focusing on global macro trends and commodities. She can be followed on Twitter @OptionsProfits.