The 2 Best Stocks to Invest in Department Stores

By Markets Fool.com

The department store business is an iffy sector for investors these days. Improving GDP growth in the U.S. and falling gas prices should boost consumer spending this year, but mall traffic has fallen dramatically since 2007. Furthermore, people are visiting fewer stores during each trip to the mall.

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As e-commerce continues to capture a growing share of retail spending, these trends are unlikely to reverse. Many department store chains have been shrinking in order to rationalize their physical footprint in line with current demand.

Two department store chains are navigating this challenging environment more effectively than their peers: Nordstrom and Macy's . To a large extent, this means diversifying away from the business of operating department stores.

Nordstrom embraces online and off-price
At Nordstrom, executives have long realized that the company's biggest opportunities lie outside of its traditional business line.

Most of Nordstrom's growth is coming outside of its full-line stores. Photo: The Motley Fool

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That's not to say Nordstrom will not build more department stores. Nordstrom has opened its first two stores in Canada in the past year, and it has another 4 scheduled to open in the next 2 years. Nordstrom will also open its first full-line store in Manhattan in 2018 and it is looking for a site for a second store there, according to several media reports.

In total, Nordstrom will open 5 new full-line stores this year. However, it is simultaneously closing lower-performing stores. In January, it shuttered two stores in the Portland, Oregon metro area.

By contrast, it is rapidly growing its off-price Nordstrom Rack store base. It opened 27 new Rack stores last year and it has scheduled another 27 Rack store openings for 2015. This is part of a broader initiative to increase the Rack store count to 300 by 2020, up from just 86 at the beginning of 2011.

Nordstrom is rapidly expanding its Rack off-price chain. Photo: The Motley Fool

E-commerce is another huge growth area for Nordstrom. Online sales more than quadrupled from $563 million in 2009 to $2.36 billion in 2014. Most of this represented the organic growth of Nordstrom's full price online operations to being a $2 billion business, but the acquisition of flash-sale site HauteLook and the launch of the Nordstromrack.com off-price site also contributed.

Full-line stores remain big profit drivers for Nordstrom and still account for more than half of its sales. But the company's management recognizes that there's limited room for growth in its full-line store base. Gaining e-commerce share and growing its off-price business will allow Nordstrom to continue posting high-single digit sales growth for the foreseeable future.

Macy's moves the same way
Like Nordstrom, Macy's has wholeheartedly embraced the rise of e-commerce in recent years. Macy's -- which is more than twice Nordstrom's size in terms of revenue -- had already reached about $2.25 billion in online sales by 2011, according to Internet Retailer. Online sales surged another 41% in 2012.

Macy's stopped reporting e-commerce sales growth in 2013. By that point, the company's "omnichannel" retail strategy had blurred the lines between in-store and online sales enough that Macy's management didn't find the distinction useful anymore. (For example, how would you classify an item ordered from Macys.com on a smartphone from inside a Macy's store?)

Macy's is also diversifying beyond physical department stores. Photo: The Motley Fool

Macy's has continued to adapt its business as the e-commerce revolution unfolds. Every year, it closes a handful of underperforming stores. Macy's has also turned its stores into mini-fulfillment centers to support online sales. Even so, comparable sales growth has slowed to a crawl.

To reignite growth, Macy's is taking a page out of Nordstrom's playbook and looking beyond the department store format. In the most obvious parallel, Macy's announced earlier this year that it plans to start testing a new off-price concept in order to capitalize on the growing popularity of that retail format.

Macy's also recently acquired luxury beauty retailer Bluemercury. Macy's will continue to operate Bluemercury as a stand-alone business, but it will use its considerable financial resources to accelerate Bluemercury's store growth. Macy's also plans to add some private-brand Bluemercury products to Macy's stores and even open Bluemercury boutiques within some Macy's locations eventually.

Department stores aren't likely to disappear anytime soon, but it's not a growth business, either. The best way to invest in the department store industry these days is to bet on forward-thinking companies like Nordstrom and Macy's that are adapting to consumers' changing shopping habits rather than fighting the trend.

The article The 2 Best Stocks to Invest in Department Stores originally appeared on Fool.com.

Adam Levine-Weinberg owns shares of Nordstrom. The Motley Fool recommends Nordstrom. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.