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CEO Richard Baker is pushing into Europe, remodelling flagship stores and moving more upscale. But the struggling chain still needs to cut costs and figure out what to do with its real estate properties

Top 1000 Rank #27 | 2016 revenue $14.4 billion | 2016 loss $15.6 million

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What does a department store retailer do when department stores are falling out of favour and the traditional bricks-and-mortar retailing concept is struggling for relevance? In the case of Hudson's Bay Co., it expands—a lot.

Last year, HBC announced that it would soon open up to 20 Bay and Saks Off 5th stores in the Netherlands. That was the latest in a series of major growth initiatives and acquisitions in recent years. In 2012, the company bought its New York-based department store affiliate, Lord & Taylor Holdings LLC. The following year, HBC governor and executive chairman Richard Baker snapped up Saks Inc. for $2.9 billion (U.S.). In 2015, HBC bought Germany's Galeria Kaufhof chain, and last year, the company acquired Gilt Groupe Holdings, Inc., a New York City-based online retailer.

HBC may not be done buying yet. "We do see ourselves as a global consolidator," Baker said in a quarterly conference call with financial analysts in April. Already, HBC's global store count under all its brands has more than doubled since 2012, to about 480 outlets. Its annual sales have expanded nearly fourfold, to $14.4 billion.

But here are the big problems for investors: HBC's same-store sales have declined, it has reported five straight quarters of losses, and its share price has slid more than 65% from a peak two years ago. This dismal performance puts it in the same company as other traditional department store chains, including Sears, JCPenney, Macy's and Kohl's, and raises the question of whether a bigger HBC is a better HBC.

The entire sector is being squeezed hard. The advantage of displaying a variety of brands in one place means little when consumers—especially millennials—prefer to shop online. Add to the mix costly price promotions, an often dismal in-store shopping experience and competition from surging fast-fashion specialists such as H&M, and it's a wonder that some of the weaker department store chains still exist.

The biggest winner amid all the disruption is Amazon. The online retailing giant has reported average annual sales growth of 22% over the past three years. Its revenue is expected to climb above $166 billion (U.S.) this year—more than double the combined revenue of Sears, JCPenney, Macy's and Kohl's in their most recent fiscal years.

Traditional department stores are trying—and failing—to keep up online. Executives use terms like "omnichannel" to describe a retailing environment where shoppers can browse online and then buy in person, or vice versa. But traditional chains keep closing unprofitable outlets across the United States. "We know the upside for profit and revenue exist," said Marvin Ellison, JCPenney's CEO, in a call with analysts in May. "We simply have to move faster."

HBC is pursuing a somewhat different strategy. Baker is pushing into Europe because he believes opportunities are limited in North America. Here, he told analysts, "there are many, many markets that have too many department stores and too many unsuccessful department stores." That said, he believes that the top 100 U.S. retail markets have strong demographics. So HBC is being selective with store locations, and it's trying to move upscale—both Saks Fifth Avenue and Lord & Taylor are luxury brands.

HBC is remodelling flagship stores in many major cities, including Montreal, Toronto and Vancouver, to let in more natural light. It's trying to improve service too. At Lord & Taylor's Fifth Avenue store in Manhattan, an entire 30,000-square-foot floor has been devoted to dresses, a rotating pop-up shop and concierge service, to make shopping there an experience that cannot be replicated online.

But even as HBC tries to upgrade, it has to cut costs. In June, the company reported a loss of $221 million for its first quarter and said it will cut 2,000 jobs from its North American retail operations, with a total target of $350 million in annual savings. "We are going to manage this business so that we do well in any kind of market," Baker said to analysts earlier in the year when talking about expenses. "I just don't know when the market is going to get less promotional, or when or if traffic is going to improve at malls. But I do know that we can control what we spend."

Investors are clearly skeptical. HBC's share price has declined to its lowest levels since the company went public in 2012. Analysts see little reason for optimism. For HBC's financial fourth quarter ended Jan. 31, 2017, adjusted earnings before interest, taxes, depreciation, amortization and rent (EBITDAR), a key measure of operating performance, declined by 9.9% compared with the same period the year before. Profit margins shrank due to promotions, and same-store sales across HBC's chains fell by an average of 1.2%.

"Conditions in the department store industry are not improving and we believe the outlook remains highly challenged," said Mark Petrie, an analyst at CIBC World Markets, in a note. Brian Morrison, an analyst at TD Securities, said: "It is clear that the global retail environment for department stores is poised to remain challenging, specifically as the trend of e-commerce continues to evolve at a rapid rate."

But there is one bright spot: real estate. Baker, who bought HBC in 2008, is a property pro who owns National Realty & Development Corp., a privately held real estate and development firm, with his father. In many ways, HBC's recent expansion isn't just about building its collection of retail brands; it's also about diversifying its property portfolio.

By some estimates, HBC's buildings are now worth much more than the beaten-up stock market value of the company as a whole, which is about $1.6 billion at recent share prices. Some investors want to exploit this mismatch—if HBC hived off properties into a real estate investment trust (REIT), then its share price could soar. In June, an activist shareholder with a 4.3% stake in HBC pushed the retailer to do something with its properties. "The path to maximizing the value of Hudson's Bay lies in its real estate, not its retail brands," Jonathan Litt, the founder of Land & Buildings, said in a letter to HBC's board of directors.

This is not an outlandish idea. Other Canadian retailers have made similar moves. Loblaw Cos. Ltd. spun off its real estate into Choice Properties REIT in 2013, rewarding investors in both Loblaw and the REIT. The same thing happened when Canadian Tire Corp. established CT REIT in 2013.

The difference, though, is that Loblaw and Canadian Tire are solid, profitable retailers that should have no problem paying their rents. HBC is far less stable, and would be paying the equivalent of more than half of its operating profit in rent. CIBC's Petrie believes that a spinoff into a REIT "would give HBC's share price a boost." However, he's reluctant to turn upbeat on the stock, given "what we believe would be uncertain investor appetite for a predominantly single-tenant department store REIT."

Alternatively, HBC could simply sell properties or borrow against them. But, again, the value to buyers rests largely on HBC's value as a tenant, which puts pressure on the retailer to show improving trends at its stores.

"We believe that our winning model of combining world-class real estate assets, which are less impacted by short-term trends, with our diverse retail businesses will continue to provide value for the company and our shareholders," Baker told analysts. HBC is getting bigger, but whether that will revive its share price is still open to debate.