Analysis - Hudson's Bay faces tough sell as it prepares for IPO
TORONTO/NEW YORK (Reuters) - If Hudson's Bay Co wants to provide some measure of comfort to investors in its upcoming initial public offering, it might have to throw in some of its signature striped wool blankets.
The retailer, owner of two of the most venerable names in department stores - Hudson's Bay in Canada and Lord & Taylor in the United States - faces a big challenge in convincing investors it can win the turnaround game, especially with a hip and agile competitor like Target Corp (TGT.N) about to arrive in Canada.
As HBC prepares for its C$400 million ($399 million) initial public offering in Toronto, it is touting a "transformation" that includes rising sales at established stores, a figure investors watch closely.
But both chains face increasing competition, a likely medium- and long-run negative for the stock. The department store sector has grown slowly as shoppers look online or seek out discount stores.
In the United States, Lord & Taylor competes with a resurgent Macy's Inc (M.N), and in Canada, HBC faces competition from Target and other U.S. companies intent on shaking up the retail landscape.
"I think an investor in the Bay would be well-advised to wait until Target has entered the market and they have some insight as to what the business climate will be for the Bay on a real basis, not on a speculative basis," said Mark Cohen, former chief executive of Sears Canada Inc (SCC.TO) and now a professor of marketing at Columbia University in New York.
HBC says its transformation is a work in progress, with more upside to come.
"The focus will be the opportunity to close the margin gap, the opportunity to grow same-store sales," said Walter Stackow, analyst with Manning & Napier, which invests in retail stocks.
HBC has estimated it will sell up to 19 percent of the company in the IPO at between C$18.50 and C$21.50 per share, giving it a market value of C$2.4 billion, according to a fund manager who has reviewed the firm's sale documents.
The company is braving an otherwise stalled IPO market in Canada. A recent PwC survey counted three issues on the Toronto Stock Exchange in the first nine months of 2012, down from 14 in the same period last year.
HBC says it will use the proceeds to pay down debt, although it will remain heavily indebted - as of July 28, total short- and long-term debt came to C$1.37 billion.
Ryan Bushell, a portfolio manager with Leon Frazer & Associates in Toronto who manages the IA Clarington Canadian Conservative Equity Fund, said he was briefed on the IPO but is staying on the sidelines for now.
"We wouldn't be stepping into more consumer sensitive names right at this moment," he said. "We'd rather see how the market digests this IPO and see a few quarters of execution as a public company."
HBC declined to comment for this piece.
Founded in 1670, Hudson's Bay was a fur trading business long before it operated department stores, having been granted control of a significant part of what is now Canada by King Charles II. It went private in 2006, as shoppers fled to specialty retailers and U.S.-based heavyweights like Wal-Mart Stores Inc (WMT.N).
NRDC Equity Partners, controlled by U.S. real estate investor Richard Baker and his family, bought out HBC's other investors in 2008, and integrated it with Lord & Taylor, which operates 48 stores across the United States.
A recent study by consultancy Kantar Retail singled out Hudson's Bay's 90 outlets as particularly vulnerable to Target. Early HBC investors will have little chance to gauge the impact of Target's 2013 arrival in Canada before buying in.
"I wouldn't touch it (the IPO) with a 10-foot pole," said Barry Schwartz, vice president and portfolio manager at Toronto's Baskin Financial Services. "I think it's an opportunistic idea to take advantage of a pretty good market and the fact that Target hasn't made any impact yet."
With a presence primarily in the U.S. northeast, Lord & Taylor is small relative to its publicly traded peers. It had sales of C$1.4 billion last year, or roughly three weeks of revenue at Macy's, which sold Lord & Taylor off in 2006. Hudson's Bay had sales of C$2.2 billion.
HBC has focused on its two marquee banners, winding down discount chains Fields and Zellers, and selling many of its Zellers leases to Target in a C$1.83 billion deal. Home Outfitters, HBC's 69-outlet Canadian housewares chain, is not much mentioned in the prospectus.
Columbia University's Cohen said the remaining Zellers locations may prove costly to liquidate, and Hudson's Bay just doesn't have a strong market position.
High-end Nordstrom Inc (JWN.N), legendary in the United States for its customer service, will start rolling out its namesake department stores and lower-priced Rack outlets in Canada in 2014. Even Canadian luxury retailer Holt Renfrew is launching a new lower-priced banner.
COMPETITION AT LORD & TAYLOR
For its part, Lord & Taylor must take on Macy's, Nordstrom and Saks Inc SKS.N, all of which are expanding their outlet chains. Macy's is spending $400 million on its Manhattan flagship, while Kohl's and Nordstrom are opening new stores.
Last year, Lord & Taylor spent C$91 million to improve its stores, including a facelift at its Manhattan flagship. Industry experts say the chain, founded in 1826, let its high-end aura erode over the years, relying too much on discounts.
It has ramped up offerings by U.S. designers like Elie Tahari, and shows the biggest image improvement among shoppers in the last 13 months, according to market research firm YouGov. But it still lags Macy's and Nordstrom.
"Lord & Taylor has a very loyal customer base," said retail industry veteran Walter Loeb, who earlier in his career was a senior merchant at Macy's and analyst at Morgan Stanley. "But they have to build a new customer base."
Another potential problem for HBC is lagging e-commerce. Last year, it got 2.1 percent of sales online, compared with 8 percent to 15 percent for the publicly traded U.S. department stores.
Selling, general and administrative costs in relation to sales have improved in recent years, thanks in part to efficiencies from combining some of the two chains' operations.
At 35 percent of sales last year, the costs are lower than those of Sears stores in Canada, with 38 percent, but far above most of HBC's peer group. They were 22.6 percent at Kohl's and 26.7 percent at Nordstrom.
HBC's real estate, including historic buildings in major cities like New York and Toronto, could provide some floor to the stock's value, should its turnaround stumble. The company owns or ground leases more than 11 million square feet of retail space, and has long-term, low-cost leases for another 14 million.
HBC sales rose 6.4 percent from 2009 to 2011, and operating income jumped more than 17-fold as the retailer boosted store productivity and margins, but that growth could falter.
"At the end of the day, the department store category is not a fast growing category," Manning & Napier's Stackow said.
($1 = $1.00 Canadian)
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