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A Contrarian Approach To Small-Cap Retailers

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A Contrarian Approach To Small-Cap Retailers by Jay Kaplan, The Royce Funds

Portfolio Manager Jay Kaplan explains the structural and cyclical challenges facing small-cap retailers and his bullish long-term outlook for the best-managed businesses.

Watch the video here.

Small-Cap Retailers

You hear a lot about how retailing is forever dead. I have a lot of investments in retail so what is it that I see that’s different from what the rest of the world sees?


There’s clearly a challenge. Some of it is structural, some of it is cyclical. The structural is we are overstored in America, we are over-malled in America.

There’s clearly market share gains being picked up by online retailing, shipped to your home, shipped to the store. All that has had an impact. However, if you have a retailing business that has a good customer base, has a good product, and has a reason for being, there’s a good chance of long-term survivability. So that’s the structural.

Now we have the cyclical. If you look back over holiday season of 2015, sales were terrible. Part of that was weather.

That’s not great for boots and sweaters for gifting, and retailers tend to have a lot of that around the Christmas season. So that’s really not good. Consumers have money in their pockets today, but they’ve been spending that money on cars, they’ve been spending that money on houses.

They’ve been going out to eat and they’ve been entertaining. There has been no fashion trend. There’s been no reason for folks to go to the mall and refresh what’s in their closet. That is cyclical. That is not structural.

So when we look at our better businesses, we try to find the ones that have brand equity, have a franchise, have a reason for being, and try to discern between the temporary and the permanent.

I think that we’ve invested in a collection of solid businesses that even during this difficult time, are very nicely profitable, have very nice returns on capital, and in some cases, have extremely low valuations, valuations that almost predict that they are going away.

And our contrary bet would be, they’re not going to go away, and there will be a fashion cycle, and there will be a Christmas, and there will be cold weather. And there will be sales, and there’ll be profits, and if and when that happens, multiples will go up and the stocks should go up along with that.

Long-Term Outlook for Retailers

When I look at the long-term outlook for retailers, I see a few things.

I think we have forgotten that shopping is actually social. Going to the mall, going to the lifestyle center, having lunch, having dinner, having brunch, walking with friends, talking with friends is social. It is not always about I need to click and buy something now. That’s number one.

Number two: there will be stores coming out of the market. We meet with management teams all the time. We’ve had some meetings lately with some retailers, and we spent some time talking about real estate, and A-malls, and B-malls, and C-malls.

Some of the C-malls are in trouble and the retailers are talking about, how do I address the C-malls? Do I close those stores? Or do I negotiate very low rents to make the economics better?

So the good management teams understand that they have to manage their real-estate, manage their presence, and be profitable wherever they are. And at the same time, the good management teams are investing a lot in technology, in omni-channel, so that if I go into a store and I need a size 8 and they only have sevens and nines, they’ll get me a size 8. They may ship it to the store for me to pick up tomorrow. They may ship it to my house in a day or two.

So those are the things over the next three, four and give years, omni-channel, rationalization of stores, reductions of rents that I think we’ll see from the well-managed companies.


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