The Retail Mall Scene is Coming Back, But this Stock Isn't

By Tom Gibbs - February 9, 2012 | Tickers: ARO, AMZN, HOTT, LTD, SPG | 0 Comments

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The indoor regional mall has come a long way since its first appearance in the mid-1950s, where its anchor store design was a natural, destination-like progression from the strip mall alternative at the time.  After a half century of increased popularity, huge national expansion, and large profitability gains, many boldly predicted the demise of the concept due to the introduction of the online retail store.  Leading the pack, Amazon’s (NASDAQ: AMZN) explosive growth throughout the several years after its 1994 founding even sparked a Time magazine cover article – “Kiss Your Mall Goodbye” – touting the speed, cost savings, and overall enjoyment characterizing online shopping. 

Although online retailer AMZN and its peers have yet to achieve 100% market share, many would agree that the Time hypothesis was not totally incorrect.  In the two years prior to the economic downturn’s 2009 trough, nearly 400 of the largest 2,000 regional malls were shut down.  Likewise, online shopping is hotter than ever – nearly $12.7 billion was spent online in the first 25 days of November (the official “Holiday Season”), with Black Friday bringing in $816 million.  The top five retailers -- Amazon, Wal-Mart, Best Buy, Target, and Apple -- all experienced double-digit growth from the same day in 2010. 

However, despite all signs pointing toward the eventual death of the regional mall, the concept is far from dead.  Retail foot traffic also experienced a meaningful 5.1% increase this past Black Friday, and mall occupancy levels are at their strongest level in years. 

Simon Property Group (NYSE: SPG) is a REIT investing primarily in regional malls (48% of portfolio), outlets, and community/lifestyle centers; its occupancy rates from Q1 2006 to Q3 2011 are depicted below. 

Simon has reported increased investment in its mall properties, and plans to add certain shopper amenities like movie theaters and host more consumer-centric events like cooking demonstrations. 

Not so HOTT

As the buzz builds and investment dollars are poured into the newfound interest in the shopping mall, there are definitely some picks to examine more closely and those that should be avoided. 

Mall-based retailer Hot Topic (NASDAQ: HOTT) has recently found a newfound surge in investor interest, and is up nearly 26% in 2012 on reports of minute comparable store sales increases and improved earnings guidance.  Likewise, over $1 million in share purchases from two company directors has added some confidence back in the brand.  However, prospective investors should not be distracted by a one quarter performance improvement – a small turnaround yes, but hardly getting the company in the clear. 

HOTT’s retail concept focuses on a mid-to-late teen target audience with a passion for music and pop culture.  Most of their offerings focus on currently trendy music groups, television shows, and films.  One would think that such a targeted concept, which is among the only of its kind, would have a meaningful competitive advantage made even stronger through a following of captive customers.  The execution of the concept has been much less impressive over the past several years. 

One of the primary issues regarding HOTT’s strategy is its extremely optimistic growth pattern.  It is difficult to blame management for not subduing their excitement after the impressive performance of the late 1990s: sales increased at a 54% CAGR from 1997 to 2000, gross margins expanded and SGA as a percent of sales simultaneously dropped, and EBIT margins increased from 8.9% to 13.6% over the same time period. 

By 2001 the number of stores increased three-fold and same store sales began their inevitable drop.  The operating performance from 2001 to 2010 illustrates the significant destruction of value that the growth strategy experienced.

Sales in thousands, RNOA explained in footnote

Same store sales and sales per square feet illustrated above

Value Focused Growth

There is definitely a long-term, value-sustaining outcome that can stem from steady, un-cannibalizing growth.  The J. Crew Group (J. Crew stores), which was bought out five years after its 2006 IPO, offers a case in point.   

The company increased its store count by 33 between January 2009 and January 2011 (11%), and sales per square foot increased 9.1% over the same time period from $551 to $601.  Unlike HOTT, which undoubtedly diluted its brand positioning through the rapid expansion throughout the regional mall space, J. Crew has only gained in popularity and has solidified its positioning as a semi-luxury brand (of course, backing by the First Lady sure doesn’t hurt). 

Largely successful Limited Brands (NYSE: LTD), which owns Victoria’s Secret and Bath and Body Works, among other stores, has also gained success from its J. Crew-like growth strategy.  Under fire from investors who are concerned about the brand’s slow growth, CEO Leslie Wexner recently said, “We’ve been very deliberate in what we do.  We see the opportunity, but we have to build the basic set of skills…We don’t want to take a giant leap forward and a giant leap back.  We are realistic about skills we don’t have.” 

Closely-positioned Gap (NYSE: GPS) has continued to close domestic stores while it simultaneously expands swiftly in overseas markets like China and Italy.  Meanwhile, Victoria’s Secret sales per square foot rose nearly 9% in 2011. 

The moral of the story?  There’s value to be had in steady brand building initiatives as opposed to ravenous, top-line growth driven expansion strategies. 

Any Other Worthwhile Picks?

Investors looking for further opportunities that will capitalize alongside the recent resurgence in retail spending should also look at Aeropostale (NYSE: ARO). 

Coincidentally, similar to the J. Crew Group and LTD, and unlike HOTT, GPS, and competitors Abercrombie & Fitch (NYSE: ANF) and American Eagle (NYSE: AEO), ARO has experienced meaningful success while relatively limiting its retail outlet footprint.  Surprisingly for a retailer that has increased sales at a 14% CAGR from 2007 to 2011 and has increased sales per square foot by 15% over the same time period, ARO is considerably undervalued compared to its competitors.

The retail sector, including the regional mall concept that was once hypothesized to be completely broken, is making huge strides from their recent recessionary trough levels.  Especially for an industry that is marked by seasonal fashion shifts and ever-changing fads, investment success will come to those who can differentiate between the value-creating retailers that are here to stay and their value-destroying counterparts that are destined for failure. 

*Footnote: RNOA = return on net operating assets = (Post Tax Operating Income) / (Average Net Operating Assets).  Net Operating Assets = (Total Assets - Financial Assets) - (Total Liabilities - Financial Liabilities).

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