Apparel Retail

This is the time of the year when strategists are busy sending out their annual outlooks. Here on the Global Investment Strategy team, we decided to go one step further. Rather than pontificating about what could happen in 2025, we decided to harness the power of the multiverse to tell you what did happen (in at least one highly representative timeline).

Next week, please join me for a Webcast on Tuesday, December 17 at 10:30 AM EST (3:30 PM GMT, 4:30 PM CET) to discuss the economy and financial markets.

And with that, I will sign off for the year. I wish you and your loved ones a very happy and healthy 2025. We will be back in the first week of January with our MacroQuant Model Update.

Highlights COVID-19 shutdowns have intensified the pressure on the original “everything stores,” … : A combination of factors has been weighing on department stores since at least the early 2000s. Pandemic store closures have turned up the heat. … and turned an unwelcome spotlight on the future of shopping malls: Bankruptcy filings by anchor tenants pose an existential threat to already struggling malls. Shelter-at-home orders and universal telecommuting have debilitated the fashion industry, further testing malls’ resilience: Apparel retailers account for an estimated 60% of leased mall space, and their struggles are ramping up the pressure on mall operators. City-to-suburb migration may act to accelerate incumbent malls’ decline: Chester County, Pennsylvania has steadily gained wealth and population since the 1970s, but all the legacy malls within a 15-mile radius of the county seat are dead or dying. Feature Dear Client, US Investment Strategy will take its second summer break next week, so there will be no publication on August 24th. We will return on the 31st with Part 2 of the Mallpocalypse series. Best regards, Doug Peta Come On. How Can It Be That Bad? The July 31st episode of BCA’s Friday Conversations webcast series featured a construction executive who expressed the view that a considerable share of America’s enclosed shopping malls has very little value.1 Many malls, he argued, are no longer viable as originally intended and a daunting mix of financial and zoning obstacles stand in the way of repurposing them for other uses. A client in attendance thought we were laying it on a little thick. “Aren’t you being extreme?” he asked. “Why won’t things go back to normal [for enclosed shopping malls] once there’s a vaccine?” Like casinos, malls created a self-contained environment where customers would spend more the longer they stayed, ...  We confess to a weakness for invented mash-up catchphrases that refer to the patently ridiculous (Sharknado) or relentlessly overhyped (the Snowmageddon build up to potential winter storms). It was with tongue in cheek that we titled the webcast “Mallpocalypse,” but this multi-part Special Report is testament to the dire prognosis for much of the stock of US malls. Malls were under pressure well before COVID-19 emerged and they would remain under pressure even if it were already in full retreat. The pandemic has dramatically accelerated weaker malls’ demise, and few of them appear to have a path back to viability. A Brief History Of The Shopping Mall The fully enclosed, temperature controlled Southdale Center in the Twin Cities suburb of Edina, Minnesota was the world’s first shopping mall. Its 1956 opening was front-page news across the national media, which greeted it with rapturous praise. It was designed by Austrian émigré Victor Gruen, who had made his name by reconfiguring New York City’s retail entryways in a way that lured prospective consumers into stores and helped to keep them there. His mall design achieved the same effect on a much greater scale. Southdale positioned 72 stores across two levels joined by escalators and bookended by two branch department store “anchors.” The open floor plan in the body connecting the anchors allowed for unimpeded views of nearly every storefront. “A ‘garden court’ under a skylight, with a fishpond, enormous sculpted trees, a twenty-one-foot cage filled with bright-colored birds, balconies with hanging plants and a café,”2 meant to evoke the feeling of a town square, was set in the center of the mall, inviting visitors to linger. Vast parking lots stood ready to accommodate thousands of their cars (Box 1). Malls revolved around the department store anchors that promised to deliver foot traffic that their rank-and-file tenants wouldn’t find on the high street or in supermarket-anchored shopping centers. Developers couldn’t get bank funding without contractually committed anchors and most mall leases today contain a provision that automatically resets rent lower, or allows tenants to exit their lease without penalty, if multiple anchors close. Per the 2019 10-K for Simon Property Group, the country’s largest mall owner, the rounded average base minimum rent for anchor tenants with leases expiring between 2020 and 2029 ranges from $4 to $8, while the average base minimum rent for inline tenants ranges from $50 to $65. Anchors are the belle of the ball and malls that lose them risk entering a death spiral. Box 1: The ‘70s: If It Ain’t Broke, Don’t Fix It Other developers faithfully followed Gruen’s initial template during the mall building boom from the mid-fifties to 1990. The three malls within a 15-mile radius of my hometown – Concord Mall (Wilmington, DE, opened 1968), Exton Square Mall (Exton, PA, 1973) and Granite Run Mall (Media, PA, 1974) – had every element but swapped out the bright-colored birds for outsized fountains. Concord Mall meant ICEEs in blue and red cups with a cartoon polar bear, Exton Square was Baskin-Robbins’ mandarin chocolate sherbet and Granite Run was large square floor tiles with a beguiling pattern of cross-sectioned stones, but this elementary schooler’s dominant mall impression was the Niagara-like roar of the fountains, which seemed to fill every cubic foot of the area outside the stores. The Long-Running Department Store Crisis The minimum base rent comparison is not quite apples-to-apples, as anchor tenants often own their own spaces, but anchors are malls’ drawing card. As Simon’s 10-K puts it, “our [properties] rely upon anchor tenants to attract customers.” Ideally, an anchor will comfortably fill the two-level bookend spaces and bring a steady stream of consumers who may spend at the stores they pass on the way. Fit is essential: dollar store customers aren’t likely to pony up for luxury brands or the merchandise on offer at high-end boutiques. Gyms and movie theaters can absorb the space, but shopping may not be on their clientele’s agenda. ... and they counted on department stores to lure them inside it. Before the advent of category-killers in the ‘90s, department stores were an ideal anchor. They were trusted well-known brands that shoppers in their area were conditioned to seek out for a broad range of purchases (Box 2). Despite their struggles, department stores remain the go-to anchors at most malls. High-end brands like Neiman Marcus, Nordstrom or Saks might anchor a mall with luxury tenants, while Dillard’s, JCPenney, Lord & Taylor or the ubiquitous Macy’s might anchor a mall seeking a more general clientele. Box 2: The ‘80s: Best. Purchase. Ever. At 19, I ventured to the massive King of Prussia Mall for a post-Christmas department store sale where I wrote my first check with a comma to purchase a floor model Sony rack system (turntable, amplifier, receiver and dual tape deck) and a CD player. The nearly three-foot-high speakers and cabinet were an early concession to marital comity (reciprocated by the gift of higher-end bookshelf speakers) but the amplifier would keep spreading joy until 2012, when it succumbed just three blocks from BCA’s Montreal office to time and the steady thump of Crazy Horse. Unfortunately for mall operators, department stores have been losing ground for at least 25 years and openly reeling for the last ten. The big-box, category-killer stores, like Home Depot, the late Circuit City, Best Buy, Barnes & Noble, Sports Authority and the late Toys ‘R’ Us, reshaped the retail landscape in the ‘90s, ushering in power centers and stealing business from department stores’ more expensive, less specialized and comparatively thinly stocked individual departments. The steady buildup of e-commerce (Chart 1), the shift in popular appeal from suburbia to urban centers and millennials’ celebrated preference for experiences over things contributed to further erosion. Private equity’s foray into the field exacerbated the other pressures. Its modus operandi of levering its portfolio companies up to the gills left the store chains it acquired dangerously unprepared to contend with falling revenues. Chart 1Perpetual Motion Machine Perpetual Motion Machine Perpetual Motion Machine A Rotten Time For A Pandemic Many department stores and other retail chains were staggering before a sick bat straggled into a live animal market in Hubei province. The subsequent pandemic has forced a long list of them, including Neiman Marcus, JCPenney and Lord & Taylor, into Chapter 11 to shrink their debt and their cost bases under the protection of the bankruptcy code (Table 1). Several national chains not in bankruptcy are trimming their footprints as well. Nordstrom has announced plans to close a sixth of its locations, and mall stalwart Macy’s (which also owns Bloomingdale’s) wants to shutter 125 of its 850 locations (Table 2). The pandemic has cut a wide swath through apparel retailers, department stores, gyms and restaurants and the toll continues to mount. Table 1Selected Pandemic Retail Bankruptcies Mallpocalypse, Part 1: An Overnight Collapse Decades In The Making Mallpocalypse, Part 1: An Overnight Collapse Decades In The Making Table 2Selected Store Closures Outside Of Bankruptcy Mallpocalypse, Part 1: An Overnight Collapse Decades In The Making Mallpocalypse, Part 1: An Overnight Collapse Decades In The Making Chapter 11 bankruptcy offers struggling businesses a second chance while protecting the interests of senior lenders and secured creditors, but it is cold comfort for unsecured creditors. From a landlord’s perspective at the back of the priority line, the time out that bankruptcy grants an ailing debtor is an excruciating limbo when it is enjoined from initiating eviction proceedings. The landlord collects little, if any, rent and is unable to market the space or spruce it up while the tenant is shielded by the court. The Fashion Industry Was Already A Mess The outlook for department stores is undoubtedly bleak, but the fashion industry, which has relied on department stores’ retail distribution channel, may have it worse. According to a wide-ranging New York Times Magazine cover story,3 the entire fashion ecosystem has been busily devouring itself ever since the financial crisis. Although turmoil in the fashion industry would not typically register with most non-specialist investors, apparel retailers account for around 60% of leased mall space and have become another flash point for mall distress. According to the apparel component of the consumer price index, clothing prices peaked in 1998, rebounded somewhat in 2011 and 2012, and had resumed drifting lower before plunging to 1998 levels in May. The decline in women’s clothing prices has been even more severe, falling 27% from their 1993 peak to slip all the way to 1981 levels (Chart 2). One culprit has been fast fashion. Enabled by social media’s instantaneous dissemination of runway designs, nimble non-luxury retailers like Zara and H&M are able to rush their own versions into production, front-running high-end collections and compelling department stores to discount their own inventory as soon as they receive it. Chart 2Salmon Have It Easier Salmon Have It Easier Salmon Have It Easier Discounting has been ruinous for the department stores’ apparel margins, as producers’ prices have failed to follow consumer prices lower (Chart 3). Department stores struck back by presenting designers with ridiculously one-sided vendor agreements. Designers reluctantly acquiesced, lest they lose access to the stores’ once-mighty distribution channel and fail to meet their lofty growth targets. Those targets are courtesy of a new breed of investor, eager to discover the next fashion star and ramp his/her operation up to scale immediately. The accelerated timetable pushes fledgling designers to expand well beyond the capacity of their bare-bones organizations and makes an inherently fickle business even more tenuous. Chart 3Rising Production Costs + Falling Prices = A Lot Of Red Ink Rising Production Costs + Falling Prices = A Lot Of Red Ink Rising Production Costs + Falling Prices = A Lot Of Red Ink E-commerce further eroded department stores’ and other brick-and-mortar retailers’ positions, a story with which investors are already familiar. The bottom line is that department stores (Chart 4) and apparel retailers (Chart 5) have been badly lagging the broader market for an extended period. Their relative market performance is consistent with their constituents’ cycling in and out of Chapter 11. Even though they shrink their debt loads and store footprints with every trip to the courthouse, they haven’t been able to do so fast enough to overcome revenue and margin headwinds that show no signs of letting up. Chart 4Gradually, Then Suddenly Gradually, Then Suddenly Gradually, Then Suddenly Chart 5Ex-The Discount Stores, Apparel Retailers Have Gotten Crushed Ex-The Discount Stores, Apparel Retailers Have Gotten Crushed Ex-The Discount Stores, Apparel Retailers Have Gotten Crushed Then the pandemic arrived and nearly the entire white-collar workforce, ex-health care professionals, ceased going to the office or traveling to meet clients in person. For five months and counting, the primary consumers of professional attire have had no reason to wear it, much less buy more. It’s no surprise that Brooks Brothers, Ann Taylor, JoS. A. Bank and Men’s Wearhouse have been among the casualties. Overall sales of clothing fell off a cliff in March, April and May (Chart 6, top panel) but clothing stores fared even worse (Chart 6, bottom panel). Chart 6Apparelocalypse Apparelocalypse Apparelocalypse With department store anchors, who occupy approximately 30% of malls’ leasable area, and apparel retailers under siege, mall operators have few places to turn to fill their space. The new breed of anchor stand-ins – fitness centers, movie theaters and entertainment spaces – are not able to open in every state and haven’t been paying rent. Gold’s Gym, 24 Hour Fitness and Chuck E. Cheese have already filed for bankruptcy and the big movie theater chains’ future is deeply uncertain. There’s Gold In Them Thar Hills, But Someone Else Has Already Staked A Claim Green Street Advisors, the leading commercial real estate research and advisory firm, estimates that half of all mall-based department stores will close by the end of 2021. Estimates of the share of malls that will close in the aftermath range from a quarter to a third. If the US has around 1,200 malls, 300 or 400 may soon disappear. Their owners and the entities that have lent to them will recoup only a fraction of their initial investments. If their losses lead to a reduction in the availability of credit, or trigger a self-reinforcing wave of defaults and bankruptcies, they could have a broader macro impact. We will explore the potential macro effects in the next installment of the series. We close this one by noting the sad fate of the ‘70s-era malls within a 15-mile radius of West Chester, Pennsylvania. Granite Run Mall was razed in 2016 and replaced with an open-air mixed-use facility that retained the original mall’s anchor spaces. Concord Mall was sold to a buyer of distressed malls in January, which has yet to disclose its plans for the site. Exton Square Mall, which underwent an ill-fated 2000 expansion that more than doubled its leasable area, is now owned by the ailing publicly traded Pennsylvania Real Estate Trust (PEI). PEI classifies the property as a non-core asset, along with the other two weakest malls in its portfolio. The Chester County mall experience bears on a client question from the July 31st webcast: “People are fleeing cities for the countryside. Isn’t that the opportunity?” Chester County, which has the highest mean household income in Pennsylvania and the 27th highest in the United States, bucks the state’s broader demographic decline. West Chester, the county seat, added a third public high school in 2006; its university has steadily grown enrollment, increasing its share of students in the 14-school State System of Higher Education consortium from 12.1% in 2010-11 to 18.5% in 2019-20; and new highway arteries and commuter rail stations have made it much more feasible for residents to work in Philadelphia, 25 miles to the east, than it was in the ‘70s and ‘80s. Chester County has been a prime suburban development opportunity for 20 or 30 years and commercial and residential developers have been making the most of it, converting acreage formerly devoted to feed corn into high-end housing, office parks, luxury auto dealerships and other commercial uses. It’s not that the market can’t support retail, it’s that it no longer wants 50-year-old spaces that were built to serve a humbler, less affluent constituency. A range of newer open-air options featuring more upscale retailers and restaurants have supplanted Concord, Exton Square and Granite Run. The area has improved; it’s the old nags that couldn’t keep up.   Doug Peta, CFA Chief US Investment Strategist dougp@bcaresearch.com Footnotes 1 Please see BCA Research Webcast "Mallpocalypse", from July 31, 2020, available at bcaresearch.com. 2 Gladwell, Malcolm, "The Terrazzo Jungle," The New Yorker, March 15, 2004. 3 Aleksander, Irina. "Sweatpants Forever," The New York Times Magazine, August 9, 2020, pp. 28-33 and 42-43.

Feature The European stock market has a hidden gem: its clothing and accessories sector. Since the turn of the millennium, the sector’s profits are up by a thousand percent (Feature Chart). In this Special Report we propose that the megatrend has further to run, as its principle driver is still very much in place. Consumption patterns are becoming more female. Feature ChartEuropean Clothes Profits Are Up A Thousand Percent! European Clothes Profits Are Up A Thousand Percent! European Clothes Profits Are Up A Thousand Percent! One of Europe’s major, and largely neglected, success stories is the dramatic rise in the percentage of the working-age population in employment. This major success story stems from another success story: the structural and broad-based increase in the female labour participation rate – which has surged from 57 percent in 1995 to 68 percent today (Chart I-2-Chart I-4). Yet the story is far from over.1 Chart I-2European Male Labour Participation Is Flat... European Male Labour Participation Is Flat... European Male Labour Participation Is Flat...   Chart I-3...But European Female Labour Participation Is Surging ...But European Female Labour Participation Is Surging ...But European Female Labour Participation Is Surging   Chart I-4...So The Percentage Of The European Population In Work Is Surging ...So The Percentage Of The European Population In Work Is Surging ...So The Percentage Of The European Population In Work Is Surging Why Job Creation Favours Women Two things are driving the megatrend in female participation. One is a paradoxical feature of the current technological revolution. As we explained in The Superstar Economy: Part 2, Artificial Intelligence (AI) excels at tasks that we perceive as difficult: those requiring the application of complex algorithms and pattern recognition to a narrowly defined goal, such as making a highly-engineered product or managing a stock portfolio. This poses a big threat to jobs in manufacturing and finance, employment sectors which happen to be male-dominated.2 Conversely, AI still struggles at tasks that we perceive as easy: those requiring adaptable movements, or reading and responding to people’s emotions and intentions. If you are good at controlling a disruptive class of 7-year olds, or calming a nervous patient before giving him an injection, your human skills are still in big demand. But education, healthcare, and social care – the employment sectors that are creating the most jobs – employ three times as many women as men. With AI still in its infancy, the established pattern of job destruction and creation will continue to favour women over men (Table I-1). Table I-1AI Is A Greater Threat To Men Buying European Clothes: An Investment Megatrend Buying European Clothes: An Investment Megatrend The other driver of the megatrend in female participation is a raft of European legislation designed to make work more family friendly: flexible working time, generous paid maternity and paternity leave, and subsidised childcare (Table I-2-Table I-4). Sharing the responsibility of childcare between mothers, fathers and external helpers has allowed tens of millions of European women to enter and remain in the labour force. Table I-2Generous Maternity Pay In Europe And Japan Buying European Clothes: An Investment Megatrend Buying European Clothes: An Investment Megatrend   Table I-3Improving Paternity Pay In Europe And Japan Buying European Clothes: An Investment Megatrend Buying European Clothes: An Investment Megatrend   Table I-4Affordable Childcare In Europe And Japan Buying European Clothes: An Investment Megatrend Buying European Clothes: An Investment Megatrend Nevertheless, the megatrend has a lot further to run. For the ultimate end-point, look at the Scandinavian countries which started legislating such policies in the early 1970s, around twenty years before the rest of Europe. As a result, in Sweden, labour force participation rates for women and men have now converged to almost identical: 81 versus 84 percent (Chart I-5). Chart I-5In Sweden, Labour Force Participation For Women And Men Is Almost Identical EU28: Labour Force Participation Rate In Sweden, Labour Force Participation For Women And Men Is Almost Identical EU28: Labour Force Participation Rate In Sweden, Labour Force Participation For Women And Men Is Almost Identical The combination of the two drivers – employment growth favouring female-dominated sectors and employment becoming more family friendly – means that net job creation in Europe will be mostly due to more women joining the workforce. An important consequence is that consumption patterns will continue to become more female. But what does that mean? How Women’s Spending Differs From Men’s Spending In the main spending categories of housing, food and healthcare, women and men tend to show near-identical spending behaviours. But there are three sub-categories where there are significant differences. Men considerably outspend women on vehicle purchases: cars account for around 8 percent of disposable income for men versus 4 percent for women. Against this, women spend more on personal care products and services: 2 percent versus 0.5 percent. This is the reason behind our long-standing successful overweight recommendation in the European personal products sector which we maintain (Chart I-6). However, the sub-category in which women outspend men by even more is clothes and accessories: estimates average around 6.5 percent for women versus 2.5 percent for men.3 Chart I-6Personal Product Profits Set To Grow Very Strongly Personal Product Profits Set To Grow Very Strongly Personal Product Profits Set To Grow Very Strongly It follows that as consumption patterns become more female, we should expect to see a steady rise in spending on clothes and accessories as a share of total consumer spending. Has this been the case? In the U.K. – where the data is easily available – the answer is yes (Chart I-7). Having said that, other factors are also at play. A generalised deflation in clothes prices (Chart I-8) is also generating a strong tailwind to sales volumes (rather than values). More about this later. Chart I-7More Real Spending On Clothes... More Real Spending On Clothes... More Real Spending On Clothes... Chart I-8Partly Because Clothes Prices Are Falling... Partly Because Clothes Prices Are Falling... Partly Because Clothes Prices Are Falling... Of course, the more compelling evidence is the thousand percent growth in the European clothes sector’s profits since the turn of the millennium. However, with the sector dominated by top brands such as LVMH and Hermes, could a more plausible explanation come from strong economic growth, until recently, in the emerging markets such as China? The answer is yes to the extent that many of the emerging economies are experiencing the same structural uptrends in female participation, and this supports our investment thesis. Still, this cannot be the main driver, because in recent years the connection between the fortunes of the emerging economies and the European clothes sector has been weak (Chart I-9).   Chart I-9The Connection Between Emerging Markets And European Clothes Is Weak The Connection Between Emerging MarketsAnd European Clothes Is Weak The Connection Between Emerging MarketsAnd European Clothes Is Weak There is another obvious question: is the market already aware of, and fully priced for, the megatrend? We think not, as most investors we meet are surprised by the structural uptrend in female participation, the on-going dynamics behind it, and the implications for consumer spending patterns. Understandably, the European clothes sector does trade at a valuation premium to the market (Chart I-10). But for many companies, the recent market hiccup has pulled down their valuation premiums to close to, or below, the long-term average from which the price has previously outperformed very strongly. Chart I-10The Valuation Premium On European Clothes Is Close To Its Long-Term Average The Valuation Premium On European Clothes Is Close To Its Long-Term Average The Valuation Premium On European Clothes Is Close To Its Long-Term Average What Is In The Clothes Basket? Pulling all of this together, the companies in our European clothes and accessories basket need to meet several criteria: A dominant or significant exposure to women’s clothes and/or accessories. A top-end brand (or brands) giving the company pricing power, and mitigating the very strong deflation in clothes prices. Avoid ‘fast fashion’. A reputation for sustainable development. A track-record of profit growth during the past decade. A forward price to earnings (PE) multiple of less than 25. A market capitalisation of at least €5 billion. On the basis of these criteria, our European clothes and accessories basket contains four names: LVMH, Kering, Luxottica, and Burberry (Table I-5). Hermes meets most of the criteria but, trading on a forward PE close to 35 is very richly valued. Table I-5The European Clothes Basket Buying European Clothes: An Investment Megatrend Buying European Clothes: An Investment Megatrend To be clear, this is not a short-term trade. Investors who buy the clothes basket outright need to have a multi-year investment horizon. Those investors who must also protect short-term performance should instead overweight the clothes basket relative to the broad market. Dhaval Joshi, Senior Vice President Chief European Investment Strategist dhaval@bcaresearch.com Footnotes 1 Please see the European Investment Strategy Special Report “Female Participation: Another Mega-Trend” published on April 6, 2017 and available at eis.bcaresearch.com 2 Please see the European Investment Strategy Special Report, “The Superstar Economy: Part 2”, January 19, 2017 available at eis.bcaresearch.com. 3 Source: Bureau of Labor Statistics Consumer Expenditure Survey 2016 via SmartAsset, and Paymentsense.

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