By WallStreetDaily.com

Malls are scary places these days.

Derelict malls have become attractive venues for drug addicts, homeless people and even the bodies of murdered people.

Heck, why live on the cold streets of, say… Minneapolis, when there’s an empty Aéropostale to call home?

Meanwhile, malls lucky enough to still operate have problems of their own.

On the day after Christmas, CNN reported massive brawls and food court fights at more than a dozen malls across the country. Yikes.

The age of malls is over, folks.

Top retail analyst Jan Kniffen says about one-third of U.S. malls will close in the coming years.

Bottom line, capitalism forces businesses to adapt or die.

For companies like J.C. Penney and Sears, the chance to adapt has long passed.

But what about some of America’s other great retailers?

I asked my senior analyst Martin Hutchinson to drill down on the retail sector.

With a handful of once-great retailers destined for the courthouse steps, we have an opportunity to profit from their demise.

Hutch’s full report is below.

Smart investing,

Louis Basenese
Chief Investment Strategist, Wall Street Daily

Question: Martin, I’m concerned about the border adjustment tax and how it will impact retailers. I’m hearing some chatter on both sides, but by and large, it’s negative. Is this going to be a net positive or negative for retailers?

Martin Hutchinson: I think the border adjustment tax doesn’t have all that high a chance of being introduced. But if it is introduced, it will be a big negative for retailers, because most of them are big importers.

You’ve got companies like Wal-Mart, which are importing from China. Their costs will increase by 20% with the border adjustment tax, and inevitably, that’s going to affect sales. And retailers are incredibly sales dependent. So that’s one particular factor impacting retailers — but there are several others.

The main one is e-commerce, which was 8.1% of total sales in 2016, up from 7.3% in 2015. Now that’s still not a huge share of the market, but it’s eating away at the brick-and-mortar retail market steadily. And obviously, it can only get bigger. That’s a pretty big head wind, if someone else is taking market share from you every year.

And then on the cost end, there are minimum wage rises. It doesn’t matter if it’s 5% or 10%. But some places are raising minimum wage to $15 like Seattle or New York City. I mean the whole state of New York is going to $12.50.

That’s a huge increase in cost for low-end retailers like the Wal-Marts and Targets of this world. It doesn’t matter too much at Nordstrom, because they will pay more than that. But at the low end, it’s a big cost increase.

Question: Hutch, can we talk a little bit about what seems to be the end of the mall culture in this country? I have to tell you, I try to avoid malls at all costs these days, but I had to go the other day. And it was kind of depressing.

I’m one of these folks that has moved all of my purchasing, as much as I can anyhow, onto online — particularly Amazon. It’s almost depressing being in a mall these days. What can you tell us about that?

Martin Hutchinson: That’s quite right, and it’s not just the world getting older. It’s that the malls are getting older as well.

We were building 140 a year in the mid-1990s. But there were no new malls built from 2007–2012. Nearly 3% of malls in 2014 are dying. Which is defined as more than 40% vacancies. And if they’ve lost their anchor store, they’re in real trouble. Two hundred of 1,300 were said to be going out of business in 2016.

Rising interest rates, obviously, will choke off any new construction in that area. And frankly, old, unattractive malls are just not nice places to be. They will drive people toward online.

And you got some other things that will do that as well. The cost cutting, for instance, pushes people to online. For example, Eddie Lampert, who is the hedge fund guy who owns Sears, stopped cleaning the stores for several years. Now that doesn’t help traffic. As a Sears customer myself, I can assure you it was repulsing.

You can generate cash through a leaseback, which Macy’s is doing currently — and Sears has done it. But Sears is now selling outright because they’re losing so much money.

You can close and sell stores, which Sears and J.C. Penney are doing, but all that’s reducing your business over time.

So the outlook for general retailers just isn’t very good.

Question: Hutch, listening to you, it doesn’t sound like this is savable — especially for the bigger retailers. Is there a way our readers out there might be able to position themselves and profit from this?

Martin Hutchinson: Well, yes, that’s what one is always looking for. The specialty retailers will do all right. For example, Ulta Beauty is expected to report good figures and is trading on 46 times earnings. That’s probably excessive. We’re in a bull market, but the specialists probably don’t have too much of a problem.

But the general stores that are not on the top end have real problems. In other words, not the Nordstroms and the Neiman Marcuses of the world.

And so I think we can play this fairly easily.

Puts on Macy’s, for example. Its profits were down 13% in the fourth quarter. Sales are expected to be down 2% or 3% in the first quarter of 2017.

Debt was just downgraded from BBB to BBB- — so one more downgrade and it’s junk. It closed 66 stores in 2016, and it plans to close another 34 this year.

Now you know that’s not a happy picture, because if you’re closing stores all the time, you’re reducing your footprint and reducing your market share.

The company is currently trading around $32. And the $25 January 2019 puts would cost you about $3 each. Now, if Macy’s hits its October 2008 price of $7.42, you’ll make six times your money on that trade. You’ll make 238% profit even if it gets to double its 2008 price.

So overall, I think those puts at $25, costing you about $3, are a very good deal and a good value play on Macy’s — and to play the problems that retailers currently have.

Question: Not a particularly uplifting conversation today, Hutchinson, especially talking about the demise of an American institution in Macy’s. But it just proves that there are profit opportunities on the downside too, if we’re willing to look for them, right?

Martin Hutchinson: Very much so.

Question: Thanks a lot, Hutchinson. We’ll talk to you again next week. This is Wall Street Daily signing off.

Good investing,

Martin Hutchinson
Senior Analyst, Wall Street Daily

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