14 March, 2019
In a cult movie “Big Lebowski” the Dude, while enjoying a game of bowling with his friends, quotes Russian revolutionary V. Lenin: “It is just like Lenin said: you look for the person who will benefit….and, uh, you know, you know”. It is unclear whether Lenin actually have said this, but one way or another, there is a point.
According to data recently released by Coresight Research, year to date, US retailers have announced 4,810 store closures (and 2,264 store openings). Among those to close stores are such companies as Gap, Victoria’s Secret (L Brands), Chico’s FAS, Payless ShoeSource, and others. And the year only started. This trend continues for a few years already.
But let’s leave aside all the emotions and hardships faced by retailers. The question investors should ask themselves is: who will benefit from all this? Obviously, it is not real estate owners as they will be under pressure to offer lower rent and find replacement tenants. A small effort in second-level thinking and bingo! The obvious thought that comes to mind is that one possible beneficiary of lower rent prices and greater choice of available locations are restaurant chains. In addition, certain retailers with plain return-per-store vs cost-of-opening concepts can profit as well.
It is no coincidence that activist investors are starting to bite into the sector. About a month ago, activist investor Starboard Value unveiled an investment into Papa John’s Pizza chain. While activist investors acquire large stakes through a purchase of shares in the open market, this time activist investor invested into the company directly: Papa John’s issued to Starboard a convertible preferred stock in the amount of $200 million with an option to invest additional $50 million. The restaurant chain plans to use the proceeds of the investment to repay debt and also invest capital to further advance its business. Few activist investors loaded up on shares of Jack in the Box: Blue Harbour Group disclosed a 6.8% stake in November of 2018. Jana Partners decreased, but remains with a stake of 3.4% (as of January 2019). Brokerage and investment banking firm Stiefel thinks that BJ’s Restaurants is a compelling M&A target as its shares declined about 36% since August 2018 high. We think that shares of The Cheesecake Factory, as well as Dave & Buster’s Entertainment, provide investors with great stories. Both companies have low debt levels and should not find it hard to finance their growth plans.
Looking more broadly beyond restaurants, we believe that BJ’s Wholesale Club, which conducted an IPO last year is an interesting story. Capital expenditure plan estimates by the company are most probably overstated as part of the capex could be financed through sale-and-leaseback transactions, leaving more free cash flow available for distribution to shareholders. It would not be a surprise in our view if the company will announce share buyback or even a special dividend.
As Etalon Capital focuses mostly on event-driven situations, another company to note is Hudson Inc, a spin-off from duty-free retail giant Dufry AG. Its shares declined 39% from September 2018 high of $22.99, and also trade 20% below the IPO price. It is reasonable to assume that waves of the ongoing “retail apocalypse” will be felt in the airports too and Hudson should benefit from more attractive growth opportunities.
To sum this up, despite the fact that retail apocalypse is ongoing for a long time already, if the investors are willing to look more broadly beyond the retail industry itself, it might not be too late yet to profit and find attractive investment options.