Why Shorts Are Betting on Big Markdowns in Department Stores -- Ahead of the Tape

By Steven Russolillo Features Dow Jones Newswires

The struggling American department store has one corner of the market salivating.

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Investors who short stocks have zeroed in on brick-and-mortar retail, with department stores bearing the brunt of the pressure. The percentage of retail shares out on loan, presumably to short sellers, has risen to 6.6%, the highest in at least four years and more than double the level seen more broadly in the S&P 500, according to IHS Markit.

Three of the 20 most heavily shorted retail stocks are J.C. Penney Co. Inc., Nordstrom Inc. and Kohl's Corp. They, along with Macy's Inc., are set to report quarterly results this week. Short sellers, not shareholders, should have cause for cheer.

Changing shopper habits and the increasing dominance of Amazon.com Inc. have contributed to the struggles of bricks-and-mortar retailers. A survey published last month by Morgan Stanley found that Amazon is now the second-largest U.S. apparel seller, gaining share largely at the expense of department stores.

Analysts expect Macy's and Kohl's to report first-quarter earnings per share, revenue and same-store sales down from a year ago. J.C. Penney's results aren't expected to be much better. All three are in the process of closing or shrinking stores.

Though Nordstrom is the best-positioned of the bunch, it, too, has its issues. Analysts estimate Nordstrom earned 28 cents a share in its fiscal first quarter, up 2 cents from a year earlier. Revenue for the period ending in April is expected to have increased 3.2% to $3.8 billion.

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Nordstrom is going in the other direction of its shrinking competitors. It has plans to open one full-line store and 15 new Nordstrom Rack locations this year. Yet, while those discount stores are popular now, their marked-down items weigh on margins. Nordstrom's pricier stores aren't as profitable as they used to be, either. And while its online business is grabbing a greater share of its overall sales, that expansion doesn't come cheaply. Nordstrom's return on invested capital was 9.7% last year, its lowest in 13 years and well below its five-year average of 13%.

Shares of Macy's, Kohl's, J.C. Penney and Nordstrom are all down over the past three, five and 10 years. All four are part of the "Death by Amazon" equal-weighted index compiled by Bespoke Investment Group, which fell to a four-year low in March.

Nordstrom has held up better than most. But the stock still commands a hefty premium, fetching 17 times projected earnings over the next 12 months. Most of its rivals have a forward multiple closer to 10.

No wonder investors are heavily short the stocks. Some 16% of Nordstrom's float was out on loan, up by one-fifth over the past month and the biggest month-over-month increase among the four department stores, according to IHS Markit.

Of course, nothing moves down in a straight line and heavily shorted stocks often rally sharply on even mildly pleasing news. Even a whisper of good news in such a bearish environment could prompt these stocks to pop. And all four have had impressive rallies over the years.

Yet another rebound doesn't change the grim prognosis for the American department store.

(END) Dow Jones Newswires

May 10, 2017 15:46 ET (19:46 GMT)