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Jonathon Fite: Can Black Friday save retail?

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Jonathon Fite

"Retailing is very tough, and I think the online thing is hard to figure out."

— Warren Buffett, 2017 Berkshire Hathaway shareholders meeting

Black Friday, traditionally the biggest shopping day of the year, is right around the corner. The sales boost could not come soon enough for most retailers.

Jonathon Fite 
Jonathon Fite 

2017 has been rough for those peddling their wares. Since its peak in December 2016, the entire retail sector is down 20 percent (as measured by the Retail Exchange Traded Fund, or XRT), even with online giant Amazon gaining 50 percent in the same time period.

This performance likely reflects the wave of retail bankruptcies that have washed across the markets in 2017. So far this year, retailers have defaulted on nearly $11 billion of debt (according to the Crux investing newsletter).

This fall, Toys R Us filed for Chapter 11 bankruptcy. While many of the big-box toy retailer's roughly 1,600 stores are profitable, the company has so much debt that it can't pay its bills. During a leveraged buyout in 2005, the company's private equity sponsors piled on $5 billion in debt. Even with interest rates at multi-generational lows, the company can't make its interest payments.

Toys R Us is hardly alone. There's been a rash of retail bankruptcies this year: The Limited, Wet Seal, HHGregg, RadioShack, Payless ShoeSource, Gander Mountain, Gymboree, Rue21 ... and the list goes on.

While the shift to e-commerce transactions has definitely changed the retailing game, online sales make up less than 10 percent of all retail purchases in the United States. Brick-and-mortar stores are still very relevant, making up more than 90 percent of all retail sales.

But recent studies have shown the U.S. has three to four times as much retail space per capita as other major developed economies. That seems a little excessive and may explain why we are seeing the highest number of store closures since the recession. Credit Suisse expects more than 8,600 closures before the end of the year vs. 6,163 stores shut down in 2008, the worst year for closures on record.

So what are investors to do?

Some may be bold enough to buy Amazon stock even with it trading at insanely high price-to-earnings multiples (P/E). Yet, that was true a year ago and its shares still performed well this year.

Value investors are likely to cringe at those prices and hunt for better bargains elsewhere. Wal-Mart is much cheaper by comparison, fetching a P/E ratio close to 22. Yet, this is twice as expensive as it was when our partnership bought shares in 2011.

Other retailers like Macy's or J.C. Penney Co. may appear to be bargains, yet it is easy to see that mall-based retailers may be structurally challenged. Perhaps it's easier to just avoid the sector altogether?

Indeed, that may be best the answer for many investors. But for those willing to do some homework, the "death of retail" fears may create some real opportunities.

For example, North Texas-based retailer The Container Store recently saw its shares climb nearly 50 percent after reporting strong earnings on the back of efficiency gains and same-store sales growth. Early this year, management pointed to expectations of strong performance in the second half of 2017. But the market sold off TCS shares this summer, giving value investors an opportunity to load up.

The Container Store's focus on high-end personal organization and custom closets is hard to replicate by the likes of Amazon and Wal-Mart. Perhaps some retailers will survive after all.

The key is finding good management teams running good businesses, and to buy them at a bargain price. Isn't that what we are all shopping for on Black Friday?

Jonathon Fite is a managing partners of KMF Investments, a Texas-based hedge fund. He is an adjunct professor with the College of Business at the University of North Texas. This column is provided for general interest only and should not be construed as a solicitation or personal investment advice. Comments may be sent to email@KMFInvestments.com.