By and  on August 20, 2013

It’s not a done deal yet but an eager Richard Baker has been touring Saks Fifth Avenue locations, eyeing potential closings as well as capital improvements, and locations that could be converted to Lord & Taylor units.

There is clearly work to do. On Monday, Saks Inc. reported second-quarter numbers that were weak, sparking speculation among vendors and analysts about what Baker, the chairman and chief executive officer of Hudson’s Bay Co., could do to improve Saks and its anemic profitability. It’s a business which, like Neiman Marcus, is widely viewed as having limited growth potential, but the cachet endures and Baker has an adventurous streak that could take the brand in new directions.

“Today you have to take risks and be creative to make the business distinctive and draw people to the brick-and-mortar. Saks’ online business is strong but it’s also the biggest competition to the stores,” said an industry source.

On July 29, HBC revealed its deal to buy Saks for $2.9 billion, including debt. The deal is seen closing in two to five months from now, though Saks is going through a 40-day “go-shop” period allowing it to seek better offers. The Neiman Marcus Group, along with KKR, made a late bid before HBC’s offer was accepted and could still be interested. However, a bid topping HBC’s would be expensive and time-consuming, and would include a breakup fee to HBC. Regulatory filings put the break-up fee at $40.1 million during the go-shop period, which concludes Sept. 6. KKR might also pursue Neiman Marcus, which has filed the paperwork for a public offering while alternatively remaining open to an outright sale.

Saks’ net loss in the second quarter ended Aug. 3 widened to $19.6 million, or 13 cents a share, from $12.3 million, or 8 cents, a year earlier. Last quarter’s losses included $2.5 million in expenses from the deal with HBC, a $1.6 million pension settlement charge and $1.1 million in store-closing costs.

Excluding these items, losses would have tallied 10 cents a share, 2 cents steeper than the 8 cent loss analysts projected on average.

Sales, up 0.5 percent to $707.8 million from $704.1 million, were behind the $732.6 million analysts projected. Comparable-store sales increased 1.5 percent. Gross margins fell to 36.6 percent of sales, from 37.2 percent a year earlier.

“While the second quarter was our 14th consecutive quarter of posting a comparable-store sales increase, our sales growth was modestly below our expectations,” said Stephen I. Sadove, chairman and ceo. “This shortfall contributed to our second-quarter year-over-year gross margin rate decline and SG&A expense deleverage.”

Lawrence Leeds, managing director at Buckingham Research, believes Saks will benefit from the HBC takeover. “It’s a case of two and two make five. I don’t think anyone else could get the same level of economic synergy with Saks. The economics are unmatched.”

Industry executives see at least $100 million in annual savings through consolidations and layoffs, and some top management changes at Saks are likely, possibly involving Sadove, though they won’t be revealed until after a deal is concluded.

“Companies like Neiman Marcus and Saks Fifth Avenue run a bit fat,” added Isaac Lagnado, president of Tactical Retail Solutions. “They have a lot of expenses they could trim if they wanted to. But that could kill the golden egg. These are not commoditized businesses. They recognize they have to reinvent inventory virtually every year, they recognize these are very discretionary purchases and that they need people talking to new designers, looking for new trends. That is a very different model than The Bay [now called Hudson’s Bay], which has a large commoditized, more predictable business.”

“Saks has a major problem. Their excellence is confined to maybe eight locations and the rest is marginal,” said one Wall Street investor. “Neiman’s stores for the most part are around the same size. Saks can’t really carry the assortments to compete with Neiman’s in those small stores.” Because of the challenges, market sources believe Baker will accelerate the growth of the three most profitable elements of Saks, which include:

• The Off Fifth outlet chain currently with 69 units. New and existing Off 5th units are adopting a “luxury in a loft” design for merchandising flexibility, ease of shopping and an elevated ambience.

•, which is the fastest-growing segment at the retailer and steadily being merchandised for greater consistency with the stores and more upscale product.

• The Fifth Avenue flagship, which accounts for about 25 percent of the chain’s total business. Baker, with bigger coffers than Saks has, could revisit past renovation schemes at the flagship that never materialized, including possibly creating a lower-level selling floor to expand jewelry and accessories, both currently crammed on the main floor, and bolster cosmetics. Saks’ cosmetics, 10022-Shoe and the premium contemporary brand departments are considered standout performers. Men’s wear is gaining ground, particularly in private label.

Aside from the flagship, some of Saks’ stronger locations are in Beverly Hills, and Boca Raton, Sarasota, Naples and Bal Harbour, Fla. Saks units in Raleigh, N.C.; Richmond, and Santa Barbara, Calif., are said to be among the weakest. Over the last decade, 20 Saks locations have been closed, including 12 in the last three years. By the beginning of 2014, the count will fall to 40 locations.

Earlier this year, Sadove acknowledged a handful of closings for the future, though he didn’t specify which ones or how many. Baker has already said he plans to invest substantial sums renovating Saks stores, that he will re-brand certain Hudson’s Bay stores as Saks, or Saks stores as Lord & Taylor, and may even insert Saks into certain larger Hudson’s Bay boxes to beef up productivity. In Canada, there might be the opportunity to build from ground up a new Saks store, Baker added. He foresees up to seven full-line Saks stores and 25 Off 5th outlets in Canada, and furthering Saks’ Internet business by establishing a Canadian Canada is already’s largest international ship-to market.

Another possibility for expansion, which Sadove alluded to at Saks’ last annual meeting in June, was the possibility of rolling out new specialty stores that could be under different Saks formats. Sadove didn’t specify any formats, but 10022-Shoe could be considered.

Others say that two other strategies are critical to closing the productivity gap with Neiman’s. Saks generated sales per square foot of $436 last year, while Neiman’s hit $535 in its fiscal year ended July 28, 2012. Baker must somehow re-energize the sales force to build better customer loyalty and productivity, and he must push for more launches and exclusives. Saks lags the Neiman Marcus Group on both fronts.

Saks is also pressured by current business trends, where auto sales and spending on homes seem stronger than apparel spending. Deutsche Bank analyst Paul Trussell said in a research note that Saks’ weakness was driven by a combination of unseasonable weather, a focus on big-ticket purchases, consumer fatigue and, perhaps, luxe brands’ efforts to court consumers directly.

Trussell also noted that Saks as well as Macy’s Inc., Nordstorm Inc., Dillard’s Inc. and Kohl’s Corp. all ended the second quarter with “inventory levels above current sales trends.”

“The promotional environment will be heightened heading into [the second half], with sharper discounts and quicker markdowns likely throughout the season,” he said.

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