Valuation Guide: Department Stores

|||Valuation Guide: Department Stores

Valuation Guide: Department Stores

Industry Description

The department store industry (SIC 5311, NAICS 45211) consists of retail establishments that sell a variety of products such as clothing, cosmetics, footwear, and home furnishings, typically through decentralized points of sale throughout the store.  Department stores may also offer various services such as hair styling, photography, gift wrapping, and personal shopping.

Global department stores revenue is estimated to reach $839 billion by 2018.[1]  U.S. department store industry generates approximately $170 billion in revenue per year.  It represents 3.6% of sales in the U.S. retail industry.[2]  U.S. department store sales has been declining, both in terms of absolute values and percentage share of total retail industry.

Department stores compete with a wide range of other retailers including warehouse stores, specialty shops, and e-commerce platforms.  For example, in its most recent annual report, Macy’s lists Amazon, Bed Bath & Beyond, TJ Maxx, Gap and Neiman Marcus all as competitors.[3]  Competition has increased dramatically due to the internet, which gives consumers access to stores that may not have a physical location in the immediate area.  E-commerce platforms operate with significantly less overhead cost, and many provide customers with more affordable options and benefits, such as price comparison.

Typically, larger department store chains are able to leverage on economies of scale through purchasing, distribution, and marketing.  Smaller department stores must compete based on unique merchandise or superior customer service.  Because of the advantages bestowed upon larger chains, the U.S. department store industry is dominated by large firms.

Industry Trends

Trends in the department store industry are primarily driven by changes in the world economy.  A few of the most significant changes are:

  1. In many countries, big-name department stores are struggling with falling sales, declining profit margins, and operating losses.  This trend has persisted for over a decade in many countries, like Germany and the United States.  The primary reason is the increasing competition from mono-brand apparel retailers, such as Gap, in the 1990s, then from e-commerce and fast-fashion stores in the 2000s and 2010s.[4] With online shopping websites, like Amazon, increasing its focus on fashion and apparel, the negative momentum of department stores is expected to continue.
  2. Shopping preferences have shifted.  According to U.S. Department of Commerce, the share of goods in personal consumption has decreased while the share of services increased consistently, which is another negative influence to the growth of the department store business.[5]
  3. Direct-to-consumer sales further replaces a piece of department store’s sales.  Selling directly to consumers create a better feedback loop compared to selling to department stores for manufacturers.  Direct-to-consumer also provides consumer with benefits, such as rarely out of the sizes and potentially better discount promotions.[6]
  4. Not all market players are struggling – luxury department stores significantly outperformed the industry and the overall industry decline was primarily contributed by the middle-market subsector.  Premium and high-end department stores, such as Nordstrom and Harrods, witnessed robust annual growth from 2010 to 2014, while midmarket retailers, such as JCPenney and Sears US, had negative annual growth over the same period.[7]  Premium department stores offer strong customer services and unique in-store experience that e-commerce cannot provide.  Meanwhile, department stores are also enhancing online shopping experience of their customers, offering services such as in-store pickup and free return. Department store retailers providing both strong online shopping and in-store experience are expected to outperform the industry as a whole.
  5. Department stores and specialty stores are expected to close less profitable locations at a faster pace in the future.  More bankruptcy and consolidation transactions are expected to occur.  With this transformation, US department store retailers may be able to absorb the overcapacity and improve their profit margins.

Key Performance Metrics

The following are performance metrics that managers in the retail industry use to benchmark their performance against others in the industry:

  1. Gross margin return on investment (GMROI)
  2. Sales per square foot
  3. Sales per employee
  4. Inventory turnover
  5. Sell-through percentage
  6. Average consumer spend
  7. Net profit margin

Industry Organizations and Publications

Some organizations that publish helpful information about department stores include:

  1. National Retail Federation: www.nrf.com
  2. Intercontinental Group of Department Stores: www.igds.org
  3. International Association of Department Stores: www.iads.org

Summary of Valuation Approaches

There are four commonly accepted valuation methods that should be considered when valuing a department store.  These methods are:

  1. Asset-based valuation: This method calculates a business’s equity value as the fair market value of a company’s assets less the fair market value of its liabilities.  This approach is also sometimes referred to as a “cost based approach”; that is, the business’s value is equal to the cost of acquiring its physical assets. This approach is seldom used for a department store being valued as a going concern because the value of a retail business is more closely related to its earnings and cash flow.
  2. Income approach to value (capitalization of earnings): This method is most applicable to companies that face predictable and constant growth in earnings and have a long history of operations.  The business value under this method is equal to the cash flow projection for one year divided by a capitalization rate (i.e. the appropriate discount rate less the predicted growth rate).
  3. Income approach to value (discounted cash flow): The value of equity utilizing this method is equal to the present value of free cash flows available to equity holders over the life of the business. This method works well for both established companies with low growth rates as well as new companies with higher rates of growth, but requires predicting changes in future cash flows.
  4. Market approach to value: This method utilizes market indications of value based on metrics from guideline publicly traded department store companies and privately held businesses.  The financial metrics of public companies or those of private transactions can be used to create valuation multiples that are then used to calculate business value.

Benchmark Statistics

The following benchmarking data is based on studies from various department store companies:[8]

 

2015

2014

2013

2012

2011

Gross Profit %

40.3%

36.3%

39.9%

38%

36.3%

Net Income before taxes %

6.3%

1.5%

2.4%

2.7%

4.2%

Sales/Fixed assets

17

19.5

18.5

15.2

27.4

Inventory Turnover

3.6

4.0

3.9

4.3

4.6

 

Before using this data for specific valuation purposes it should be evaluated for appropriateness.

Availability of Publicly Traded Comparable Companies

Many of large department store chains are publicly traded companies. The availability of financial data for publicly traded department stores makes it possible to compare a subject company to industry benchmarks and apply industry multiples.  When valuing a department store, however, it is important to use benchmarks and multiples based on companies that are similar to the subject company.

The top five publicly traded U.S. department store companies, ranked by market capitalization, are:[9]

  1. Ross Stores, Inc.
  2. Macy’s, Inc.
  3. Nordstrom, Inc.
  4. Kohl’s Corporation
  5. J.C. Penney Company, Inc.

The trailing twelve month price to earnings ratios of these companies range from negative (not meaningful) to 25.1.  The trailing price to sales ratios range from 0.16 to 2.14.[10]

Availability of Private Purchase Transactions

In addition to publicly traded department stores, data regarding privately held companies can provide a useful benchmark when valuing a business. However, these benchmark market multiples are generally too variant to be useful without further analysis. As with selecting publicly traded guideline companies, care should be given to select private transactions that share similarities with the subject company.  The financial metrics of a potential guideline transaction should be compared with those of the subject. Specific factors that are unique for each company must be considered.  Additionally, industry economic conditions also vary over time, which can affect department store businesses as investment opportunities.

Fulcrum Inquiry performs business appraisals for department stores and other businesses.

___________________________

[1] Market Research, Department Stores Market Research Reports & Industry Analysis

[2] U.S. Census Bureau, Annual Retail Trade Report

[3] Macy’s Inc, Annual Report 2015

[4] Fung Business Intelligence Centre, Global Department Store Retailing

[5] U.S. Department of Commerce

[6] Forbes, 5 Trends That Will Change The Way Your Customers Will Shop in 2017

[7] Fung Business Intelligence Centre, Global Department Store Retailing

[8] Risk Management Association (RMA), Annual eStatement Studies

[9] Nasdaq

[10] Yahoo Finance

 

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