LBX Investments
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Market Commentary

Notes from Las Vegas: What We Learned at ICSC RECon

Macy’s and Kohl’s Generate Cautious Optimism, While Kroger Initiatives Spark Interest    

REITs Continuing to Actively Sell Assets As Investors Remain Wary of Power Centers

 

Key Takeaways from the International Council of Shopping Centers’ 2018 Event (RECon) in May

We attended ICSC’s 2018 RECon in late May, and after dozens of meetings with retailers, REITs, service providers and investors, left with several takeaways: (1) Strong quarters by Macy’s and Kohl’s generated widespread but cautious optimism at the conference; (2) Grocery-anchored retail continues to outshine power centers; (3) Expect REITs to continue selling assets for the foreseeable future in order to fund significant expenditures; (4) Several recent tech investments demonstrate the underlying financial strength of companies such as Kroger, but the impact of those acquisitions is yet to be determined; and (5) some retailers are beginning to relax exclusivity clauses in order to attract more shoppers. 

Strong Quarters By Macy’s and Kohl’s Boosted Sentiment, But One Good Quarter Is Not a Trend

Just prior to RECon, both Macy’s and Kohl’s announced better-than-expected quarterly sales and earnings. This led to positive news coverage of retail which, in turn, translated to positive sentiment at the conference. Like many in the industry, we are optimistic but still cautious. Macy’s and Kohl’s (and some others) may be starting to figure out how to compete in today’s retail environment, after years of stock price and operational difficulties, but one quarter does not equate to a trend. In our view, the largest challenge for many of the department stores is that they have too much space. As they improve their e-commerce capabilities, move to smaller footprints, and become more efficient, we believe they will need to shed some of their expensive real estate obligations. In that regard, Macy’s may show others the way: in February, they signed agreements to sell part of their State Street store in Chicago and Union Square building in San Francisco to developers.

Grocery-Anchored Centers Remain Attractive to Investors; Power Centers Less So

Competition for well-located grocery-anchored centers appears to be increasing. This isn’t new for centers located in the urban core, but several institutional players are exploring grocery-anchored strategies in growing secondary markets. This does not mean investors are acquiring grocery-anchored centers indiscriminately; stronger players like Kroger, Whole Foods and Publix continue to attract investor dollars but weaker grocers like Winn-Dixie are still struggling to attract financing and are trading at elevated yields. A similar bifurcation exists with big box tenants. In general, power centers are trading at somewhat wider spreads than grocery, but strong tenants such as Ross, TJ Maxx, Marshalls, etc. will still trade at tight spreads in strong markets. Of note, however: investors perceive significantly greater risk if boxes are oversized relative to tenant target sizes, because footprints continue to shrink. Burlington, for instance, used to average ~80K SF per store and now targets footprints of 35-45K SF. In general, the need for space continues to be reduced.

REIT Disposition Activity Expected to Persist Throughout 2018, But Don’t Expect Fire Sales

REITs should be net sellers in 2018 (and likely beyond). Shopping center REIT stock prices have been depressed for the past few years – pushing up REIT leverage ratios and limiting opportunities to raise public equity – and many REITs have robust re-tenanting, redevelopment and development requirements (see Chart 1). Some REITs are capitalizing on private-public arbitrage to buy back shares at elevated cap rates for the benefit of their shareholders, as well. Despite increased selling activity ($750MM+ in 1Q18) there is not a widespread fire sale. Some REITs are under less stress financially and have less need to unload assets, while others were very aggressive sellers in 2016-17 and are under less pressure to sell in 2018. Still, as REITs sell non-core assets and invest into urban centers at lower cap rates, we anticipate plenty of acquisition opportunities in 2018. 

Source: LBX Investments

Kroger Acquisition of Ocado Highlights Broader Trend, But What Growth Strategies Will Win?

Kroger has been tackling industry headwinds by cutting prices, adding apparel lines and online ordering options, and over the past two weeks, investing in Ocado (delivery logistics) and Home Chef (meal kits) (See Chart 2). Much has been made of traditional brick-and-mortar retailers investing in omnichannel strategies in order to grow market share and fend off threats from Amazon. Interestingly though, while retailers like Kroger and Walmart pursue aggressive tech-focused strategies, using their capital to invest in their own platforms and third parties, a dichotomy is emerging. Premier operators such as Publix and TJX are thriving with a heavy emphasis on customer service and experience and a lighter emphasis on e-commerce. Kroger and Publix often compete head-to-head – which approach will lead to more success over time?

 

Source: LBX Investments

Source: LBX Investments

Some Retailers Embracing Strategies and Approaches That Can Drive Additional Traffic to Centers

We are seeing a subtle shift in retailer flexibility. In certain situations, some retailers are willing to waive exclusivities (which prohibit competing tenants within a center) in exchange for improved site traffic. Additionally, some larger tenants are seeing value in targeted small-space leasing strategies, which can significantly improve a center’s quality.

Additional Quick Reads for Investors

• Ad Age: Macy's Picks Publicis Groupe (5/29/2018)

Macy’s continues to emphasize digital

• Automotive Logistics: E-Commerce Automation: Ocado Bags a Revolution (2/23/2017)

Technical summary of Ocado

• Reuters: Kimco's US Asset Sales Show Public-Private Gap (4/17/2018)

Demonstrates gap between public and private pricing

• Forbes: Beginning of A Department Store Renaissance? (5/23/2018)

Measured commentary on Kohl’s and Macy’s

• Footwear News: Six Of Your Favorite Stores Are Shrinking (4/4/2018)

Shrinking retailer footprints

• Wolf Street: Is PetSmart Next? (5/25/2018)

Watch the pet space; we are, closely.

Disclaimer

This report is for distribution only under such circumstances as may be permitted by applicable law. It has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. It is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities.

Heath Binder