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Forever 21 Bankruptcy: Should You Shun Retail Stocks?

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The US retail sector has seen a bloodbath in the last five years, peaking in 2017. The latest to join the list of ailing US retailers is Forever 21, which filed for bankruptcy on Sunday. Forever 21 received $275 million in credit from JPMorgan Chase and $75 million in capital from TPG Sixth Street Partners.

The company applied for the closure of about 178 stores across the US. The retailer currently operates 815 stores in about 57 countries. Forever 21 stated that this restructuring attempt would enable it to focus more on its profitable business and move away from its international outlets.

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What went wrong with Forever 21?

In a bid to stay in the game and not close its doors forever, Forever 21 is seeking court protection. The company stated that it doesn’t aim to exit any of the leading US retail markets, as most closures would be in Asia and Europe. Many theories are making the rounds as to why Forever 21 is in this position.

Sky-high lease rentals at malls and declining foot traffic pushed Forever 21 down the path of bankruptcy. Coupled with this situation, the company reported shrinking cash reserves and dipping sales for the past few quarters.

Forever 21 is primarily a brand for fashion-conscious teenage girls. Adding outfits for males and the older generation confused the identity of its product line. The idea wasn’t executed as desired, and loyal customers felt lost.

Secondly, the rise of microbrands aggressively used influencer marketing through YouTube and Instagram. Forever 21 never explored influencer marketing to the fullest.

A recent piece in Forbes stated that the company has an unimpressive online presence compared with Zara and H&M. This is also the age of sustainable couture, and people look for eco-friendly options. Forever 21 didn’t realize the importance of sustainable fashion, and it didn’t revamp its products accordingly.

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After Forever 21: The state of other ailing retailers

The retail sector in the US has been grappling with severe issues in the wake of a potential recession. Termed the “retail apocalypse,” brick-and-mortar stores across the US have hit some turbulence. Since 2017, more than 8,000 retail stores in the US have faced closure.

In 2019, 4,300 stores are due for closure. In 2018, iconic toy store Toys R Us closed around 800 of its stores. JCPenney (JCP) plans to close 27 stores in 2019 and said that there could be more closures in 2020.

Amid declining sales and industry pressure, Macy’s (M) plans to shut down 13 of its stores. Earlier this year, The Gap (GPS) announced its restructuring plans, which include the closing of about 230 stores in the next two years.

The US retail sector has been struggling with the proliferation of online stores, a shift in customer preferences, and cautious spending by consumers. The companies also had issues in securing loans from banks. Leading banks such as JPMorgan Chase and Bank of America trimmed their exposure to retailers in 2017.

In the early days of e-commerce, Amazon (AMZN) and eBay (EBAY) sold limited product lines. These e-commerce outlets grew exponentially and redefined the retail format on a global scale.

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Is the brick-and-mortar format dead?

Does the rise of online shopping mean that the brick-and-mortar stores will be extinct? No. The retail sector is going through a phase of reinvention and disruption. Forrester Research forecasts that e-commerce could account for 17% of the total retail sales by 2022. Additionally, digitally influenced offline sales could account for an additional 41%.

These projections suggest that e-commerce is here to stay, but we can’t expect it to annihilate traditional retail stores. Although there is still enough room for conventional retail stores to survive, they need to remodel and revamp their operations to keep up.

If retail stores want to survive in this e-commerce driven world, they must integrate themselves with the online stores. ComScore predicts that by 2020, nearly 50% of the searches will use voice search. So, retailers need to use local listings and make their presence felt online—only then will the buyers be directed to the desired store near them.

The application of high-end data analytics and artificial intelligence can help retailers automate tasks and realize significant savings. The McKinsey Global Institute states that the retail industry could reap benefits from AI of $400 billion–$800 billion.

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To survive in this immensely competitive landscape, retailers need to operate as ecosystems and not as individual entities. Online giants like Amazon and Alibaba become an e-marketplace, service platform, and digital content provider all rolled into one entity. So, brick-and-mortar retailers must redesign their business models to be a part of the ecosystem to capture a larger market share.

Should you avoid retail sector stocks?

Not really. I believe the problems are not always industry-related, and they could be due to the company’s operational inefficiency. While disappointing earnings for retailers like The Gap and Macy’s have led analysts to predict further gloom, many are still upbeat about retail stocks.

Cowen is optimistic about Target (TGT) and raised its price target to $130 from $120. Cowen noted that Target is prepared to weather an economic downturn. Other retail stocks that analysts favor are Walmart and Costco.

There are four primary qualities that could insulate retailers from macroeconomic headwinds. These factors are their ability to foresee trends, investment in innovation, deciding on appropriate pricing, and enhancing the customer experience.

Deloitte has projected 4%–5% growth in holiday retail sales this year. Daniel Bachman, Deloitte’s US economic forecaster, noted, “The economy is still growing, albeit at a slower rate. Additionally, we continue to see consumer confidence elevated, which also helps boost holiday spending.”

It will be interesting to see whether the holiday optimism overshadows the concerns over Chinese tariff.

Target stock has soared 66.3% year-to-date, while Costco has rallied 42.6%. Meanwhile, Gap stock has slumped around 30% year-to-date, and Macy’s stock has plummeted 45%.

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