Photographer: Sarah Blesener/Bloomberg
markets

One Kind of Store Is Beating the Retail Apocalypse

One Kind of Store Is Beating the Retail Apocalypse

  • Sector outperforming online retailers since Toys ‘R’ Us closed
  • Specialty chains have a strong presence in mid-cap ETFs
Photographer: Sarah Blesener/Bloomberg

It’s the age-old story of the retail business: When one door closes, another opens.

For years, experts have predicted a so-called retail apocalypse as well known chains like Sports Authority Inc. and Payless Shoesource Inc. went bankrupt. The most recent high-profile victim was Toys “R” Us Inc., which liquidated in the middle of March after a failed rescue attempt.

But a funny thing happened on the way to Armageddon. In the wake of the toy giant’s collapse, a corner of the industry known as specialty retailing, where stores focus on smaller, niche categories, has been on a roll. And for investors looking to capitalize, that’s meant a shift from large capitalization stocks to mid caps, where many specialty retailers reside.

Since March 15, the day Toys “R” Us announced it was going out of business, the S&P 500 Specialty Retail Index has more than doubled the return of the S&P 500 Internet and Catalog Retail index. The move is earnings driven, as over that time almost all of the companies in the S&P 500 Retailing Index have reported their quarterly results, with about 70 percent beating forecasts, according to Bloomberg data.

“A lot of the retailers had very good same-store sales, and what that shows is the traffic is still there for people and now it’s a matter of how do you convert traffic to buyers?” Joe “JJ” Kinahan, the chief market strategist at TD Ameritrade, said by phone. “Retailers themselves have gotten much more creative and much better at helping their clients.”

Stellar earnings from companies such as luxury purveyor Tiffany & Co. have powered the specialty retail index higher. Tiffany reported strong sales growth in the quarter ended April 30, raised its profit forecast and announced a share buyback plan of $1 billion. That’s helped propel Tiffany shares to a gain of about 26 percent this year.

Mid-Cap Strategy

One way for investors to play this growth without fully diving into retail is to buy a mid-cap index fund.

For example, two-thirds of the companies in the specialty retail index appear in the $23 billion Vanguard Mid-Cap ETF, ticker VO, which is the second-largest exchange-traded fund focusing on mid-cap companies. It tracks the CRSP US Mid Cap Index, which targets companies that fall between the top 70 percent to 85 percent of investable market capitalization, according to the Center for Research in Security Prices website.

Retail makes up 6 percent of VO, the fund’s fourth-largest industry holding. The largest mid-cap ETF, the iShares Core S&P Mid-Cap ETF, which goes by the ticker IJH, has 5.2 percent of its holdings in the retail space. The $47 billion fund only allocates more cash to real estate and banking. 

There are 48 U.S.-centric ETFs that focus specifically on mid-cap stocks, according to Bloomberg Intelligence, compared with nearly 100 products that focus on small caps. Looking at the three largest mid-cap ETFs, retail makes up more than 5 percent of each, putting it among the five largest industry allocations.

Cheap Retail

The strength of mid-cap retailers is hardly an anomaly -- the entire industry is doing well. S&P 500 Retailing Index is the best performing group this year, up nearly 22 percent. And there could be more room to run.

Some retail stocks are cheap compared to historical valuations. The S&P Retail Select Industry’s price-earnings ratio has fallen to 14 after peaking near 35 in 2014, putting the index 36 percent below its five-year average of 22.

Still, the market isn’t exactly buying the idea that specialty retailers can continue to beat their internet rivals -- at least if fund flows are any guide.

Investors poured about $42 million into the Amplify Online Retail ETF, ticker IBUY, in May, making it the best month in the fund’s history. The two-year-old ETF holds companies that make at least 70 percent of their revenue online. Meanwhile, VO lost around $5 million in assets this month, and the SPDR S&P Retail ETF, ticker XRT, which tracks the broader retail industry, has seen $15 million in outflows.

“You definitely get some of the more hated retail names,” Bloomberg Intelligence analyst Eric Balchunas said of mid-cap ETFs. “But keep in mind, if there’s a real move to value, some of those could do well.”

That’s already starting to happen, as seen in the strength of specialty stores. It’s no longer just the internet retailing moguls like Amazon.com that are leading the pack higher.

“The retail sector is breaking out on both an absolute and relative basis to the broader consumer discretionary sector, and internet vendors can no longer take all the credit as the source for the industry’s recent strength,” Gina Martin Adams, chief equity strategist for Bloomberg Intelligence, wrote in a recent report.

— With assistance by Heather Burke