4 Retail Value Traps

- By Jonathan Poland

The retail industry is changing due to the rise of e-commerce. And with the closure of L Brands Ltd. (LB) stores, it appears a cycle rotation is going to be occurring. That means investors who put money into these stocks will likely underperform the overall market.

Dillard's Inc. (DDS)

In the last decade, Dillard's has seen its revenue and earnings decline. While the stock had a 10 times run after the housing crisis, the stock has lost about 60% of its market value since April of 2015. Management has continued to discount merchandise, thereby hurting the operating margin. Investors can look for similar events to persist in the second half. Historically low oil prices are playing an increased role due to Dillard's presence in the Southeast where many household incomes are closely tied to the commodity. Over the last year, its earnings have fallen more than 50% and many analysts see further declines into 2017. So while the stock is priced at 10 times earnings and the return on equity seems solid above 14%, the company and its shareholders will probably suffer going forward. Sellers have seized the opportunity by building a 20% short interest in Dillard's, picking up that the company carries over $837 million in total debt. Sometimes that is good, but this time it is not. David Einhorn (Trades, Portfolio) owns close to 6% of the outstanding shares, but both Jim Simons (Trades, Portfolio) and Steven Cohen (Trades, Portfolio) have sold out.

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Express Inc. (EXPR)

Express is a special apparel retailer with 18,000 employees to feed. So far, it has done a good job of driving higher revenue even though it has not translated into net profits. This is not purely a numbers trade, but even with high return on equity rates, the company spends most of its profit on capital expenditures. In the last five years, its stock is down 47% and should be avoided at this point as I do not believe it will ever provide much long-term value to shareholders. Retail in general is a tough business and I think the big mega-malls we Americans have built over the last few decades are going to be forced to change. Express and stores that were once "hot" will be the first to go. The company itself cited key reasons for the decline in year over year earnings were a reduction in mall traffic and an intense promotional environment. In the past, companies that had stores captured, to varying degrees, a barrier to entry advantage. Now, everyone can be a retailer online. Cohen has taken a 1.68 million share position in Express, good for 2.13% of the stock. I do not believe "betting" in this stock will finally turn it around and make shareholders money even with a price-earnings multiple under 10, especially in 2017.

Buckle Inc. (BKE)

In the world of brick-and-motar fashion retail, Buckle is a decent brand, pays out a great yield (4.65%) and has produced solid numbers in the last decade, going from $56 million in earnings on $530 million in sales to over $147 million on $1.1 billion last year. All this while keeping the capital expenditure well under 50% of net profit, producing 27% return on equity rates and accumulating over $212 million in cash, zero debt. Solid results, better than most, yet comparable-store sales decreased 12.1% through September of 2016. In addition, for a billion dollar brand, its online sales and social media "game" are not on point at all. In fact, 2017 is possibly a year for transition. The stock has not lived up to the company's financial numbers because retail is hard. And when you do not sell online very well, it gets harder. No wonder 46% of the stock is sold short. The good news for existing shareholders is that Buckle has enough cash and a potentially bright future to continue paying out $1 a year in dividends, for now. In addition, it has a solid management team that governs well, owns stock in the company and does not have outrageous comp plans. While guru Chuck Royce (Trades, Portfolio) owns 6% of the common stock, the position makes up such a minute portion of his whole portfolio that even if it went to zero, the pain would hardly be felt. With the short interest so high on the back of 18.5% total sales declines, even at 10 times earnings Buckle still looks scary.

Bed Bath and Beyond (BBBY)

Finally, a personal favorite for many people only goes to demonstrate why social benefit does not equal investor benefit. It is funny that airlines are now hot, but retailers are not. I am certain that this will reverse eventually, but for now companies like Bed Bath and Beyond will struggle to deliver shareholder returns. In the last decade (2007 to 2017), the company has lost 1.42%. In that same time, it has doubled revenue and earnings per share (thanks to buybacks) and provided a truly great customer experience to be emulated across industries. Sadly, shareholders have not benefited, a trend I believe will continue no matter how well the top or bottom line does. Granted, the bottom line outside of buybacks is only 21% higher today than it was 10 years ago, a result that does not inspire confidence in its high growth capabilities. Bed Bath & Beyond is one of the better-operated companies in the retail industry, but when anyone can be a retailer and reach millions via social - who cares!

In closing

Unless you are a private equity firm with the resources to buy any of these companies through a leveraged buyout, your capital is better invested elsewhere. Even though these companies are all profitable and will likely survive the next decade, the value could be dragged down by those that do not. The industry must change both online and in store, which will take time, investment and some pain. A five-star business does not always make a five-star investment.

Disclosure: I do not hold a position in any of the stocks mentioned in this article.

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This article first appeared on GuruFocus.

• Warning! GuruFocus has detected 3 Warning Signs with BKE. Click here to check it out.

• BKE 15-Year Financial Data

• The intrinsic value of BKE

• Peter Lynch Chart of BKE