This Industry's Got a Dirty Secret

Alyce Lomax, The Motley Fool
Updated

The retail industry's got a dirty secret that's too often left out of the equation. The sector overexpanded, having built out based on a bubble mentality and overinflated wallets, and that's still playing out, making it difficult for many retailers to survive now. There's good reason to believe the tough times are still unfolding, even though plenty of retailers have gone bankrupt or folded over the last several years.

Take the following pieces of news. Together, these incidents help portray an American retail landscape that remains pretty grim.

  • Sears Holdings (NAS: SHLD) shut down holiday-season merriment with its plans to close 100 to 120 Sears and Kmart stores, announced in late December.

  • Last fall, Gap (NYS: GPS) said it planned to shutter nearly 200 North American stores and downsize others.

  • American Eagle Outfitters (NYS: AEO) has been shedding stores, saying last summer that it could shutter up to 100 stores over a two-year period.

  • Early this month, SUPERVALU (NYS: SVU) said it will close 20 underperforming stores in light of continued pressures on its grocery business.

Some experts don't believe retailers will fare much better in 2012, as economic reality continues to take its toll. Consulting firm Excess Space Retail Services predicts more than 5,000 store closings this year, even beyond closures related to bankruptcies and liquidations.

So many reasons; one huge one
There are plenty of factors contributing to the onslaught of store closures and shrinking retailers. The economy's still sluggish, and consumers aren't spending like they used to. Even beyond still-high unemployment and a soft real estate market, the price of gas and other commodities have hurt consumers' ability to slog through, much less fill shopping bags with more and more stuff from more and more retailers.

In many cases, the retailers in question have also lost their competitive edge and allowed their brands to become tarnished.

Overall, the bubbly environment prior to the financial crisis gave overall retail expansion some major steam, and it looked like the good times could last forever. Of course we needed a Starbucks (NAS: SBUX) on every corner, not to mention a Starbucks within a Starbucks, as the old joke goes. (Starbucks has already got the dirty work of ratcheting down its store count over with, having announced in 2008 its plans to close 600 U.S. cafes over the following year.)

The bubble, and all that temporary cash and credit sloshing around, allowed many retailers to enjoy good times; it floated truly strong businesses and weaker ones, too. Talk about a false sense of security, particularly for those who invested in some of the retailers that are struggling with their store counts now.

Reality adjustment
Investors who recognize retail's dirty little secret, the one that many people don't like to talk about, will exercise far more caution when pondering stocks of retailers that expanded past their true financial feasibility. Although Starbucks is a good example of a bubble-fueled overexpander that was able to turn its fortunes around, such feats are easier said than done.

To be safe, seek out the historically conservative growers that still promise freshness and innovation, not to mention room for expansion, even in this American economy. And think long and hard before snapping up some supposedly bargain-priced shrinking retailers' shares; your portfolio's value could shrink just as badly.

Share your thoughts on the overexpanders in the comments box below, or check out our free report on a little-known Latin American retail stock: "The Motley Fool's Top Stock for 2012." The report is free today, but won't be forever, so check it out while you can.

At the time thisarticle was published Alyce Lomax owns shares of Starbucks. The Motley Fool owns shares of Gap, Starbucks, and SUPERVALU. Motley Fool newsletter services have recommended buying shares of Starbucks. Motley Fool newsletter services have recommended buying calls in SUPERVALU. 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.

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