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The one big flaw in the bull case for HBC shares

With Canada Day looming on the horizon, it may seem patriotic as well as profitable to load up on Hudson's Bay Co. stock, especially after its big jump on Monday.

But more thoughtful investors may want to take their Canadiana in measured doses. According to one experienced observer, betting on the retailer's stock is a bit like hauling a big fish into your canoe while it is still alive and flopping, then trying to grab it with your bare hands.

"There are so many ways it could thrash around and destroy me," says Jeff Macke, president of Macke Asset Management, a San Diego-based investment firm that specializes in retailers. "Why in the world would I want to go anywhere near it?"

He argues that Hudson's Bay is sputtering as a retailer. Meanwhile, the value of its much-lauded real estate is a lot murkier than generally recognized because of the general decline of department stores. "You don't have many buyers these days for enormous flagship department stores," he says. "And there are good reasons for that."

The segment's long fall from grace reflects the relentless rise of Inc., he says. It's a generational shift that resembles how Wal-Mart Stores Inc. displaced Sears Holdings Corp. three decades ago.

Consumers' growing ability to buy nearly anything online with next-day delivery is eroding the core proposition of department stores, which is the ability to offer a myriad of products under one roof. No matter how good a department store may be, no single location can offer the sheer variety of products that Amazon does.

That simple fact casts a shadow over any valuation of retail real estate, according to Mr. Macke and others.

To be sure, some optimists take a different view. The catalyst for Hudson Bay's 15-per-cent surge on Monday was a letter from Land and Buildings Investment Management of Stamford, Conn. It asserted in a public letter that the retailer's real estate is worth far more than its current share price.

"Hudson's Bay is a real estate company, full stop," the letter says. Land and Buildings, which already owns 4.3 per cent of Hudson's Bay, is urging the company to unlock the value of its flagship properties by closing stores and putting them toward more valuable uses.

The math certainly looks compelling. By Land and Buildings' reckoning, the real estate is worth $35 a share, roughly four times Hudson's Bay's closing share price on Friday. "Even if the real estate is worth half the Company's estimate, the shares would still be worth double today's share price," the letter argues.

But how reliable is that estimate? To analysts such as Mr. Macke, it's unconvincing because any potential valuation rests on the assumption that someone will find a new purpose for the retail space. The problem is that an analyst can't just assume that past retail rents will apply, because the new user of the space might be an apartment landlord, a movie theatre, a warehouse operator or someone else entirely.

Mr. Macke is not the only observer to raise a skeptical eyebrow. A fund manager who preferred not to be named said he finds it hard to understand the general optimism that Hudson's Bay can simply choose to turn its real estate holdings into cash whenever it chooses.

Granted, the company's executive chairman, Richard Baker, comes from a real estate background and would seem to be ideally positioned to do the transaction. "But if it's so simple to turn real estate into cash," the fund manager asks, "why hasn't Baker already done it? It's not like it's a new idea."

A more positive view comes from Gabriel Lowenberg, president of Lowenberg Investment Counsel Inc. in Ottawa. "There's value there [in the real estate portfolio], but it has to be carefully extracted," he says.

Success in splitting part of the real estate portfolio away from its current retail use will hinge on finding profitable, alternative uses for the properties, he says. For instance, shopping malls have been turned into offices in some parts of the United States.

"The real estate is worth $23 to $30 a share, provided they can find a viable tenant who can use it to make money," Mr. Lowenberg says. "Otherwise it's like the popcorn business at Cineplex and the movie business at Cineplex. The popcorn business is not really a separate business."

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