A man exits a Hudson's Bay department store in Toronto, Ontario, Canada June 6, 2016.CHRIS HELGREN/Reuters
No one can agree on what Hudson's Bay Co.'s extensive collection of department stores is worth, and that sets up an intriguing opportunity for investors who thrive on uncertainty.
HBC runs a sprawling retailing empire that includes Hudson's Bay, Lord & Taylor, Home Outfitters and Saks Fifth Avenue. On Friday, reports suggested that it was shopping for one more brand: Macy's Inc.
But this empire is struggling as more consumers shop online, pushing many observers to look beyond HBC's stores and instead gaze upon the real estate in which they operate.
While optimistic observers see tremendous value here if HBC would simply spin off its properties into a publicly traded real estate investment trust – essentially divorcing retail from real estate – others are concerned that the silent cash registers cannot be ignored.
The bears seem to be winning the debate. In January, HBC lowered its full-year outlook, adding that the business environment in the United States and Europe was challenging. Soon after, the share price fell to a record low of $9.08, down from a high of $29.42 less than two years ago.
The share price has since rebounded, to $10.45, but it remains well out of line with the value that some analysts give to the properties, which runs as high as $36 a share.
Is the stock a screaming buy then? Well, maybe.
Investors have been paying close attention to the real estate assets held by retailers for the past several years.
In 2012, Loblaw Cos. Ltd. announced that it would establish a real estate investment trust to hold its properties, then valued at $7-billion. Choice Properties REIT debuted in 2013 at $10 a unit, and has since climbed about 40 per cent. Loblaw has fared well, too: Its shares have doubled.
Canadian Tire Corp. struck a similar deal in 2013, and the shares have since risen more than 85 per cent.
HBC embarked upon its own version of this strategy in 2015, with a twist: It formed two joint ventures to hold some of its properties and mulled the idea of an eventual REIT spinoff after it diversified its properties beyond Canada.
Investors loved it, sending the shares up 20 per cent on the day the news was announced. Since then, the shares have fallen 60 per cent.
As investors grow concerned about the viability of HBC's retailing businesses, the value of the company's real estate is also called into question.
Brian Morrison, an analyst at TD Securities, argued in a January note that the deteriorating retail outlook made it difficult to put a value on the company's real estate.
The bearish argument goes like this: The value of department store real estate is connected to the ability of the current retailer to pay rent. A failing retailer can't pay rent, and that hurts property values – especially in an era when consumers are turning to Amazon.com Inc.
Mark Petrie, an analyst at CIBC World Markets, noted in January that HBC pays 71 per cent of its operating profit to rent. That falls to 57 per cent after accounting for the income received by HBC from its joint ventures. Either way, that's high: Mr. Petrie said that landlords prefer rent-to-profit ratios of 20 to 25 per cent.
But there is a bullish argument here, too: HBC can survive as a retailer. And if it doesn't, its real estate will attract other tenants who can pay top dollar for attractive locations.
These assumptions underpin an estimate from Steven Salz, an analyst at M Partners, that HBC's real estate is worth about $28.50 a share if it is spun off. Wayne Hood, an analyst at BMO Nesbitt Burns, pegs the value at $36 a share – implying a huge upset opportunity over the current share price.
Will HBC spin off its real estate soon and end the debate?
The company didn't provide any hints during its last quarterly conference call in early December. Instead, it has stuck to its line that it is diversifying its assets – it bought German department store chain Galeria Kaufhof in 2015 and the rumoured deal for Macy's would expand its U.S. properties – to increase the stability and appeal of its real estate.
Investors, though, are waiting for the deal-making to end and the spinoff to begin.
David Berman