Friday Five: Retail Apparel Going Out of Style

Christine Benz: Hi, I'm Christine Benz for Morningstar.com, and welcome to the Friday Five. Joining me to discuss some of the top business and market news of the past week is Morningstar editor Jeremy Glaser.

Jeremy, thank you so much for being here.

Jeremy Glaser: You are welcome Christine.

Benz: Much in the news this week was about the retailers. Let's start with Macy's--they had a terrible quarter. Let's talk about what’s going on with that company.

Glaser: Retail was very much in focus. We are going to talk about three retailers. The first being Macy's. They really had a dreadful quarter and shares sold off pretty considerably on the results. They had comparable store sales, so for stores that have been open for over a year, were down 5.6%. They have seen just more and more declines here, and there is a lot of short-term headwinds that are hurting them. Everything from international tourists spending less, to just apparel in general has kind of been in the dumps recently. We'll talk more about that, with some of the other names.

So that's been really very challenging for them. But Bridget Weishaar, who covers Macy's for us and the other retailers for us, thinks that there are also some long-term issues here at play, this isn't just all short-term stuff that’s going to come out in the wash. That the rise of online competition, lot of the challenges facing department stores in terms of capital investment they need to keep doing to keep their stores looking fresh. And really thinking about the way that the consumers are turning away from these type of stores, it's going to be really hard for them in the future to continue to do well, and they are going to continue to see these challenges. So even with the decline we saw in share price, we still don't see a lot of value in Macy's today.

Benz: If shoppers weren't at Macy's were they at Gap stores?

Glaser: It doesn't appear that they were there either. Gap gave sales update for the first quarter in April, we've got earnings next week. But they also were quite weak in guidance for earnings, was quite weak as it seems like people aren't buying apparel at Gap stores either. But unlike Macy's, Bridget thinks that a lot of what's happening to Gap is more of the short-term cyclical issues. They are better positioned, they have better brand equity for the future. We actually see the shares as quite attractive right now. But that doesn't mean it's not without risk. One of the things that Gap really needs to work on is shortening their lead time in terms of their supply chain--of going from an idea of a new item to get in time in store shelves--shrinking that is really important. Because it keeps you from having a lot of inventory of things that you don't really want and that you might have to mark down and that obviously can hurt margins. So there is risk of executing that strategy of continuing to shortening that time. But Gap is working on that--it's something we think will be successful and like I mentioned the shares are in 5-star territory right now.

Benz: Last retailer I'd like to discuss is Kohl's, also supplying its earnings news this quarter and not a good quarter for Kohl's.

Glaser: It was not. To complete the trifecta here. Kohl's really had another poor quarter with sales unexpectedly falling, there were expectations that they would gain slightly there. And again they are seeing same kind of cyclical headwinds, but we think that there also are those long-term issues that they are going to see as well. Particularly for Kohl's and a lot of other kind of these mass market broad category retailers. So they sell lot of national brands and those are very sensitive to price competition. I know if I am buying something …

Benz: Nike.

Glaser: Nike or Under Armour I can price those out across a bunch of different retailers, I can look online if it’s cheaper online, I'd probably go and buy it there versus going to the store. That’s going to put pressure on price because you are going to have to compete on price there. That's going to hurt profitability over time. So even though we might be at a point in the apparel cycle where things look pretty bad and they are going to get better, we still are going to have some of those long-term issues at Kohl's and just like Macy's we see those shares as being fairly valued right now despite the decline in share prices.

Benz: One thing I wanted to talk about with you Jeremy is, the secular problems with some of these apparel retailers. You and I have talked off camera about this issue and I was wondering if it's maybe some of the fast fashion companies encroaching on retailers like Macy's and you noted the online retailers have certainly cut into the business. But do you think that there is sort of a broader trend afoot here?

Glaser: I think that some of it is that people are shopping elsewhere for their clothes. But it does seem like apparel is just an unfavored category right now. That consumers would rather spend money on travel, on eating out, on other experiences--that seems more important to people than fashion right now. There aren't any big trends that people want to go out and really be part of and that's hurting those apparel manufacturers quite a bit. You also see that other just kind of necessities of life. As housing prices come back up and rents come up quite a bit. You look at the cost of health insurance and other costs that people really have to bear on a monthly basis--those are taking up a bigger share of the wallet and leaves little room left over for apparel. So I think we are seeing some shifts away from people seeing buying clothes as being important. And we're really seeing that in a lot of these results. Again some of it is cyclical, we have some weather issues. We have some other concerns but it definitely is something to keep an eye on.

Benz: Another consumer name in the news week this week. Disney had a mixed quarter let's talk about what’s going on there.

Glaser: Surprisingly it wasn't a great quarter for Disney given the success in their film business, Star Wars, Zootopia, some other films did very, very well and really powered a good quarter in that part of the business. But if you look at the media networks, which is ESPN is what people primarily focus on these days and also the consumer products side, it didn't look quite as good and that held back results a bit. In the theme park side; the domestic parks looked good. But some of the expenses that are leading up to the opening of Shanghai Disney that really also weighed on those results there. So altogether it was kind of mixed quarter--we did see the shares sell off a bit. But Neil Macker, who covers Disney for us, isn’t concerned. He thinks that actually this presents a pretty good entry point for Disney shares. He sees it as a wide-moat company that has a bright future ahead of it. And thinks that if you have been kind of waiting on the sidelines looking for a good entry point we could be getting close to that right now.

Benz: Last news story we want to cover is LendingClub. Let's talk about what that company does. It took a tumble this week. Let's talk about its business and what the problems have been recently.

Glaser: LendingClub is an online lender that really acts kind of as a conduit, makes the loans for people and then sells them to third parties, and it was that selling portion that has gotten them into some trouble this week. They said that--as their CEO departed and three other top executives departed--that there was a revelation that a relatively small sliver of the loans that they sold, that there was some impropriety there. They changed some dates to make them fit into different packages. They had investors who said they only wanted certain types of credit quality and that kind of misrepresented them a bit there. So we don't know exactly everything that happened but definitely does seem that there was a lack of internal controls, and that really led to the departure of those top executives. That certainly leads to lot of concerns about the business.

In general, given they operate in this space, in lending you really would hope that they would have those controls very firmly in place and they need those in order to have the investors who are willing to take these loans. So the stocks have really just tumbled on this news. But Michael Wong, who's our analyst here, also thinks that we should even look past that and there are other question marks in the quarter. If you look that loan growth slowed, if you look to some of the charge-offs were going up, some other concerns just about the business--even putting aside those very serious questions about internal control. So we have LendingClub under review right now. We kind of take all of this into consideration, but definitely some important questions surrounding the firm right now.

Benz: OK. Jeremy thank you so much for your insights.

Glaser: You are welcome Christine.

Benz: Thanks for watching. I’m Christine Benz for Morningstar.com.