Sunday, June 22, 2008

Chain store ponzi schemes.

There is a great graph over on the site, Calculated Risk, which shows the massive expansion of Commercial Real Estate in the last five years.

Can you say bubble?

(Even if you don't like this subject, at least read the italized section below and tell me that doesn't blow your mind....)

Essentially, since 1997, the average expenditure on CRE has been 20 billion, (in 1997 dollars, the first year of the graph). Over the last few years that has exploded into 25, 30, 35 billion.

This at the same time that the internet has been making inroads on the brick and mortar stores.

I'm going to make a very bold prediction here. In ten years, stores like Pegasus and the Bookmark will be all the rage, while the chain stores will be shunned.

Huh? That's impossible.

Well, not if you see the chain stores as a giant ponzi scheme.

Let me explain. When I got into sports cards in 1985, my sales exploded. And yet my cash flow was strained to the breaking point. I just couldn't keep up. I finally went to the bank and borrowed money. I did it by opening a second store. I could show the bank that I was making steadily increasing sales, and the overall profit and loss statement looked good -- but what it didn't show was that I was generally broke on a cash flow basis. Summer and Christmas every year would bring me to profitability on my taxes, but I spent most of the year in the hole.

I expanded again a few years later, and then again. Each time, I borrowed money to fuel the expansion, and each time the new store brought in an infusion of cash.

But each time it was a temporary solution to my cash flow problem, because the profit margins were barely enough to keep up. When the sales actually started to drop (my first experience with a bubble) the expansion became a huge negative.

I managed to slowly draw back to one store, which is more profitable than the four stores were.

But it looked good for awhile. The banks weren't asking the right questions. How much was real cash profit, and how much was just expansion of inventory? What was my cash flow like?

They focused on sales, and that's where I directed their focus. I didn't hide anything, I just highlighted the positives, and didn't try to explain away the negatives unless they brought it up.

I believe the chain stores are doing the same thing; but for every Amazon, which actually had a well reasoned plan for expanding sales while not being profitable, there are dozens and dozens of chains that are constantly expanding and borrowing and building and raising money on the stock market -- who ultimately can't survive on a 'real' level of sales; who once the expansion stops for any reason, will fall apart, who have fooled the stock market by ever expanding 'sales', even when those sales are cannibalizing existing stores.

Each expansion I made brought in ever higher sales, but each time with less per capita return.

I think the chain stores are doing the same thing. Building huge, cheap buildings, jumping from 'fad' retail concept to 'fad' retail concept: indoor malls, to factory outlets, to outdoor malls, to big box, etc..., constantly expanding product lines, constantly searching for the cheapest place to manufacture and buy goods. (Imagine China asking Walmart for just a bit more....)

Again, there are solid chain stores, but there is a huge number of very shaky chains as well. The vacancy rate in the malls is continually expanding, and yet more malls are being built.

I have found me a new website: Keypoint Partners retail round-up. It's one long litany of new CRE; empty malls; failing chain-stores; kick rich quick ponzi schemes revealed; management shakeups; new retail concepts (fads!); etc.

The latest wrinkle is that it turns out there are a number of chain stores who have been PAID to anchor malls; who's whole profit structure comes from free rent, and constantly opening stores, and not actual sales.

From Calculated Risk:

The WSJ has an article about fast growing retailer Steve & Barry's facing possible bankruptcy. This story has an interesting twist: Steve & Barry's Faces Cash Crunch

[S]ome of the forces pushing Steve & Barry's growth were not tied to end-consumer demand, but the needs of mall owners in a softening commercial-real-estate market. Much of the company's earnings came in the form of one-time, up-front payments from mall owners. Those payments were designed to lure the retailer to take over vacated sites, say several people familiar with the company.

Without these payments, the stores are barely profitable, if at all ...

Outrageous? Ask yourself how many chain stores have similar models. I doubt Steve & Berry's is the only one. When I was in the Mt. View Mall there was the rumor that Penney's was getting essentially free rent as long as the mall didn't perform well. Don't know if that example was true; but suspect it's indicative of many of the leasing arrangement by the big anchor stores.

Which makes the whole structure suspect. Sure, they can feed off the weakness of CRE for a few years, but if CRE goes down, so do the parasites.

I think when the mass market begins to weaken: looking shabby, raising prices, having less selection and service (first thing they cut is staff) etc. that the specialty stores will look like an oasis. Especially if the consumer wakes up to the fact that the five button shirt at Walmart ("Why does my shirt gap so much?") isn't a real savings over the six button shirt at your local clothing store.

And especially if the consumer has the epiphany that more cheap goods isn't what they really want or need. A few quality goods won't clutter your house, will be higher quality and give more life and pleasure, and at the same time support your local economy.

I have faith that will happen, eventually.


Duncan McGeary said...

Well, sorta. Faith is probably too strong a word.

Hope, maybe.

RDC said...

I think that you have a bit of wishful thinking there with your implication of business returning to Mom and Pop stores.

There are some chains that are weak and will fail. Others will not. The retail environment will continue to evolve not much differently then it has in the past.

Duncan McGeary said...

Yeah, I was overstating the case. "All the rage" may be pulling a few percentage points of Market Share -- which would be a huge shift for us, a tiny shift for them.

I'm not sure I agree that the retail environment will continue "not much differently" though. Did you see the graph? That is a lot of CRE to absorb. In a recession.

There is a 2 or 3 year lag in CRE, as well. Some of the chains are talking about pulling out of commitments to malls and shopping centers if they see others pull out:

"Viral Patel, real estate negotiator for Plano-based Penney, said the company is going back over previously approved projects and delaying them "if the growth isn't going to be there."

Regardless, all deals are going through a stringent screening, including asking other retailers if they are committed to projects, Mr. Patel said."

Or this:

"Projects that are being built in phases with two- and three-year lead times are also losing tenants as financing tightens, Mr. Weber said.
Irving-based Michaels Stores plans to open 45 stores this year, the same number it has built in each of the last 10 years, said Karen Slayton, real estate manager for the largest U.S. arts and crafts retailer. But the company will back out of a project if it's the only one left, she said."

Or this:

"Major retailers such as Home Depot, J.C. Penney, Michaels Stores and Toys R Us say they want to hear about future projects but are scrutinizing the details more closely.

"We need a cooling-down period," said Hunter Stansbury, senior real estate manager for Home Depot Inc., which recently said it was closing 15 stores for the first time in the Atlanta-based chain's history."

Or this quote dealing directly with the housing bust:

"The home furniture and furnishings category accounted for 27 percent of the total 4,600 store closings in 2007, according to the International Council of Shopping Centers."

All these quotes are from the Keypoint Partners site.

I can easily envision a world were local will become more important, and the big guys collapse of their own weight.

You're probably right that it won't be overnight.

RDC said...

Oh you will some retrenchment. Some are not in good shape. Some will use this as an opportunity to close under performing stores and to stop projects that should never have been approved in the first place.

Some will go ahead with the intent of grabbing market share for the rebound.

What is happening in a number of caes are a shifting of retail locations from old strip mails to new ones built around the big box stores. The vacancies seem to be occuring more in the non-big box centered strip mails or in the older ones (in some cases that used to be anchored but the big box closed or shifted to a new location.