Markets

Nir Kaissar is a Bloomberg Gadfly columnist covering the markets. He is the founder of Unison Advisors, an asset management firm. He has worked as a lawyer at Sullivan & Cromwell and a consultant at Ernst & Young.

The conventional wisdom is that brick-and-mortar retailers are dying, and online retailers are killing them. Pick your stocks accordingly.

Investors have been doing just that. The S&P Retail Select Industry Index is down 10.9 percent this year through Wednesday, including dividends.

Out with the Old
Investors are fleeing brick-and-mortar retail stocks
Source: Bloomberg
Note: Total return indexed to 100.

But the headline number doesn’t tell the whole story. By my count, the index has 80 traditional and 16 online retailers. Those online sellers have returned 30.8 percent this year on average, while the traditional ones are down 14.6 percent.

Investors will soon be able to do more than dump their shares of traditional retailers. ProShares Advisors LLC plans to issue three brick-and-mortar doomsday ETFs. One fund will buy stocks of online retailers and sell short -- or bet against -- the stocks of traditional ones. A second will offer a double-leveraged short against traditional retailers, and the third will offer a triple-leveraged short.

Not so fast, says Target Corp. It predicted on Thursday that its same-store sales would grow in the second quarter after declining for four consecutive quarters. The announcement gave traditional retailers a jolt. As my Gadfly colleagues Brooke Sutherland and Sarah Halzack pointed out on Thursday morning, “Target jumped about 4 percent in early trading, while Wal-Mart Stores Inc., Kroger Co. and Costco Wholesale Corp. also climbed.”

Bargain hunters are now wondering whether the worst is over for traditional retailers, but they should first ask whether those retailers are as beaten down as the prevailing wisdom suggests.    

To find out, I looked at the financial results of the companies in the S&P Retail Select Industry Index for each of the last 10 fiscal years. I excluded companies whose financial results weren’t available for the entire 10-year period. I then separated brick-and-mortar from online retailers. I was left with 40 traditional and 16 online sellers. 

I then compared the two groups using three value metrics -- price-to-book, price-to-earnings, and price-to-cash flow ratios -- and three quality metrics -- profit margin, return on equity, and debt-to-equity ratio.

There are lots of surprises in the numbers. The first is that traditional retailers aren’t particularly cheap. For example, their average P/B ratio is 3.6, which is higher than the 10-year average ratio of 3.2. Their average P/E ratio of 16.9 is comparable to the 10-year average of 16.8. And their average P/CF ratio of 9.6 is only modestly lower than the 10-year average of 10.7.

Hanging Around
It's not clear that traditional retailers are cheap or struggling
Source: Bloomberg
Note: Averages for 40 traditional and 16 online retailers in the S&P Retail Select Industry Index based on fundamentals from latest fiscal year.

Another surprise is that traditional sellers aren’t doing as badly as the breathless headlines imply. Their average profit margin of 4 percent is low, but comparable to the 10-year average of 4.5 percent. Their average return on equity of 17.5 percent is more impressive, and it, too, is just modestly below the 10-year average of 18 percent.

Granted, the debt load of traditional sellers has crept up over the years. Their average debt-to-equity ratio is 74 percent, compared with a 10-year average of 55 percent. But that’s still well below the S&P 500’s D/E ratio of 113 percent.      

Full Retail
The valuation and financial performance of traditional retailers have been surprisingly steady
Source: Bloomberg
Note: Averages for 40 traditional retailers in the S&P Retail Select Industry Index for the last 10 fiscal years. P/B and P/E shown as ratios; profit margin and ROE shown as percentages.

It’s not even clear that traditional retailers are doing worse than their online competitors. Yes, online retailers are enjoying far higher profit margins -- 22.8 percent for online compared with just 4 percent for brick-and-mortar rivals. But traditional retailers win if the measuring stick is return on equity -- 17.5 percent for traditional compared with 13 percent for online. Either way, the difference can’t be attributed to leverage because both groups have comparable debt-to-equity ratios.

Bargain hunters beware: Brick-and-mortar stocks may look cheap relative to online stocks, but that’s likely because online sellers are absurdly expensive. Their average P/B ratio is 8.5; their P/E ratio is 73; and their P/CF ratio is 16.7. By those measures, a lot of assets seem like a bargain.

Of course, none of this means that investors’ worst fears about the decline of brick-and-mortar retailers won’t eventually come true. But for now, it’s far from obvious that traditional retailers are already in the dumpster.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Nir Kaissar in Washington at nkaissar1@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net