Moody’s Investors Service

U.S. department stores still face many challenges, but credit ratings agency Moody’s Investors Service said the sector is “moving in the right direction for 2017.”

The ratings agency, in a report Monday called “Department Stores Battle to Stay Relevant,” concluded that after a “difficult 2016, the sector will swing to 4.6 percent operating income growth as sales trough and margins improve from better inventory management.”

The report noted at the outset that department stores face challenges as consumers have prioritized value and convenience as product pricing becomes increasingly transparent. It noted that increased markdowns to clear merchandise by major players such as Macy’s Inc. and Nordstrom Inc. dampens consumers’ willingness to pay full price. Moody’s also said the sector’s “Achilles heel” is the slow supply chain, which can have inventory backlogs when consumer demand quickly shifts.

Moody’s said tepid apparel demand, along with the growth of the off-price sector, has squeezed department store operators. The agency expects the sector as a whole to post an 11 percent decline in operating income for 2016. Moody’s projected the off-price sector to grow to 10 percent of apparel sales by 2018 from 8.8 percent in 2015.

Declining mall traffic has reflected the shift to off-price retail and e-commerce competitors. That change has required department stores to build out their technology platforms and fulfillment capabilities in order to compete. According to Moody’s, Nordstrom’s full-line business and Neiman Marcus Group have made the most notable inroads in their e-commerce penetration to nearly 20 percent and over 25 percent excluding mytheresa.com, respectively. In comparison, most regional department stores have lagged at less than 10 percent, Moody’s said. The ratings agency also noted that Dillard’s Inc. and Belk Inc., both regional players, are more insulated from the broader competition due to their more loyal customer bases, but they’ve also invested less in building online and have lower penetration than many of the larger players.

Moody’s also said one of the sector’s biggest challenges is right-sizing the brick-and-mortar footprint as more sales shift to the online platform. No surprise that the obvious solution is to either reduce store sizes or close stores or both, but Moody’s also noted that having physical locations gives department stores a competitive advantage for product pickup or returns, as well as a point of distribution to increase supply efficiency.

For holiday, the department store sector is better positioned this time, after paring inventories in the first half to better align with weaker mall traffic. That’s one factor expected to help retailers as they head into 2017, Moody’s noted. One other suggestion the agency had for the sector was the creation of a “scarcity effect” to get shoppers to buy under threat that delay would mean an item would sell out. Moody’s said, “To create the scarcity ‘aura,’ however, means limiting product overhang. Retailers will need to reduce inventory positions and create fresher product presentations so customers feel compelled earlier in the cycle.”

Moody’s also said that for the sector to stabilize and improve market share, retailers have to keep pushing beyond their traditional channel role. It said the sector is moving in the right direction as key stores are implementing new approaches and offering merchandise that are either exclusives or are limited in distribution. Further, companies that control brands will be better able to adapt as exposure to multiple channels allows them to shift as consumers change their shopping behaviors.

All these approaches, plus a “de-weatherize” that reduces the dependency on apparel — J.C. Penney introducing appliances again and increasing its focus on the home category — are efforts that will help the sector’s performance in 2017.

 

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