Department Stores & Off Price

Transcription

1 Americas/United States Equity Research Retailing Research Analysts Christian Buss Sara Shuler Pallavi Bakshi Christine Lee Department Stores & Off Price SECTOR REVIEW The Four Keys for Broadlines Survival: Real Estate Reduction, ecommerce, Speed, Brands Under the backdrop of unprecedented change in consumer shopping behavior we have performed a detailed analysis of the relative long-term competitive position across our broadlines universe. We upgrade BURL and JWN to Outperform. We downgrade JCP and KSS to Underperform. We view M and URBN s long-term strategy favorably, but believe traffic weakness and elevated investments will continue to hamper returns over the next months. The Shift to ecommerce and Deep Value Is Inevitable and Well Under Way. Our analysis of industry growth highlights two crucial changes that we expect to drive relative market share over the next 5-10 years. First, we believe that ecommerce will grow from 15-20% of industry sales to 35-40%. Second, we believe that deep-value retail (the combination of Off Price and fast fashion retail) will grow from 20% of industry sales to well over 30%. In short, we are at (or even past) a tipping point for the traditional full-price mall environment, particularly in tier-two and tier-three locations. Sales Shifting To Lower-Return Channels. The transition to ecommerce and deep value has already disrupted store productivity, eroded profitability, and perhaps most important, shifted the marginal productivity of capital investments. Historically high ROIC investments in mall and strip center real estate assets are shifting toward significantly lower ROIC technology investments with rapid depreciation cycles. In addition, the new model faces competition from venture-backed startups with a low-margin market-share gain mindset. Under this backdrop, we have performed a detailed, proprietary analysis of what we see as the four keys for broadline retailer survival: 1. Real Estate Rationalization Inevitable as Traffic Shifts to Tier One Locations. 10 years ago, Sharon McCollam, then CFO at WSM articulated what she saw as the number one structural change she was trying to address in her business: Multi-store markets would become single-store markets over the next 20 years. She was early, and she was right. We expect the number of productive retail centers to decline by at least 25% over the next 10 years. Store closures are inevitable, and delay will exacerbate ROIC declines as tier two and three locations become increasingly unprofitable. M, URBN, and JWN look to be leading the way on this front. Over time, the question of excess real estate needs to be DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

2 addressed in the Off Price channel given accelerated square footage growth over the past five years. It is the biggest long-term risk to the Off Price channel, and an avenue for follow-up research to come. 2. ecommerce Investment The Baseline Requirement To Maintain Market Share. ecommerce currently generates more than 100% of the incremental revenue generated by the apparel industry. To put it another way, NetMarket.com s first ecommerce sale (of Sting s new album to Phil Brandenberger of Philadelphia in 1994) was this generation s opening of the Southdale Center (Victor Gruen s first enclosed shopping mall opened in Edina, MN in 1956). Our testing of online competency highlights JWN as leading the way in the broadline environment. Off Price lags. One big long-term question we have yet to answer is how to think about the role of Off Price in a world defined by the shift to online purchasing. TJX is clearly furthest along in attempting to find ways to address this big unknown following their acquisition of Sierra Trading Post, an underappreciated test-bed in their brand portfolio. One of the key tenets of our thesis on the apparel industry is that price elasticity is greater than one. In short, the retailer with a substitute good at the lowest price will take not just unit, but also dollar share. It is this reality that explains Off Price and fast fashion share gains more than any other. To this end: 3. Deep Value s Secret Sauce Is Supply Chain Efficiency. We believe that opportunistic buying, lower inventory intensity and faster speed-to-market has reduced markdown risk for both Off Price and fast-fashion retail. This lower risk has been translated across concepts into a price (and margin) advantage that continues to allow deep-value to take share within the apparel industry. While much of this advantage is already embedded in premium multiples for the group, we see BURL s catch-up opportunity to TJX and ROST here as the most compelling in the Off Price universe. Department Stores and Mass Channel retailers remain well behind the curve with their continued emphasis on fill the store inventory intensity, guaranteed margin from vendors, and over-reliance on late season promotional activity to turn inventory. 4. Access To and Creation of High-Value Brands One Offset To Deflationary Pressure. We believe one of the few offsets to the price-sensitive behavioral reality of consumers that does not require a radical long-term reworking of supply chain and buying organizations is investments in brands that consumers actively seek out. This is the clear lesson that the athletic and luxury markets with their double-digit marketing intensity have for specialty and broadlines retail. In our view, unique brands are increasingly important in light of the challenging traffic environment that marks the mall and strip centers, where compelling store environments are no longer enough to drive consumers that were already visiting the mall into your store over that of a competitor. If the 90s model was our store environment is better than yours, so we ll take the traffic, today s model has to be predicated on we have the brands you need, no one else does. JWN is furthest along on this front. On that note, retailers increasing their emphasis on private label without accelerating brand investment are in for a rude surprise. Department Stores & Off Price 2

3 Summary of Material Changes We upgrade BURL and JWN to Outperform. We downgrade JCP and KSS to Underperform. We view M and URBN s long-term strategy favorably, but believe catch-up investments will hamper returns over the next months. Please see further information on investment thesis, valuation, and risks at the end of the note. Price Price Rating* Target Price Year EPS EPS FY1E EPS FY2E EPS FY3E Company Ccy 13 Jan 17 Prev Cur Prev Cur End Ccy Prev Cur Prev Cur Prev Cur Burlington Stores, Inc. US$ N O Jan-16 US$ (BURL.N) J.C. Penney Company, Inc US$ 6.76 N U*[V] Jan-16 US$ (JCP.N) Kohl's Corporation (KSS.N) US$ N U*[V] Jan-16 US$ Macy's Inc. (M.N) US$ N Jan-16 US$ Nordstrom, Inc. (JWN.N) US$ N O Jan-16 US$ Ross Stores, Inc (ROST.OQ) US$ N Jan-16 US$ The TJX Companies, Inc. US$ N Jan-16 US$ (TJX.N) Urban Outfitters (URBN.OQ) US$ N Jan-16 US$ *O - Outperform, N - Neutral, U - Underperform, R - Restricted [V]= Stock consider volatile ( see Disclosure Appendix). Company data, Credit Suisse estimates Source: Credit Suisse research Our Take on Department Stores and Off Price Figure 1: Summary Table Of Leaders And Laggards By Criteria Real Estate ecommerce Focus on Brand Ticker Retailer Rating Transformation Investment Speed Investments Score JWN Nordstrom, Inc. O LEADER LEADER LEADER LEADER 100% URBN Urban Outfitters, Inc. N LEADER LEADER LEADER LEADER 100% BURL Burlington Stores, Inc O LEADER LAGGARD LEADER LEADER 75% M Macy's, Inc. N LEADER LEADER LAGGARD LAGGARD 50% ROST Ross Stores, Inc. N LAGGARD LAGGARD LEADER LEADER 50% TJX The TJX Companies, Inc. N LAGGARD LAGGARD LEADER LEADER 50% JCP JC Penney Company, Inc. U LAGGARD LEADER LAGGARD LAGGARD 25% KSS Kohl's Corporation U LAGGARD LEADER LAGGARD LAGGARD 25% Figure 2: Summary Of Ratings And Target Price Upside/ Ticker Rating TP Downside JWN Outperform $58 30% BURL Outperform $92 9% M Neutral $32 6% URBN Neutral $34 25% TJX Neutral $77 0% ROST Neutral $70 4% JCP Underperform $7 0% KSS Underperform $39-7% Source: Company data, Credit Suisse estimates, upside/downside calculated based on price as of 01/17/2017 Figure 3: Summary of 2017 Estimates Ticker 2017E Revenue 2017E EPS Revenue (mn) Consensus EPS Consensus JWN $15,468 $15,504 $3.23 $3.13 BURL $5,974 $5,951 $3.83 $3.75 M $24,650 $24,851 $2.92 $3.23 URBN $3,752 $3,707 $2.14 $2.03 TJX $35,085 $35,432 $3.84 $3.79 ROST $13,647 $13,687 $3.20 $3.13 JCP $12,791 $12,811 $0.24 $0.57 KSS $18,338 $18,709 $3.60 $3.73 Source: Company data, Credit Suisse estimates, Thomson Reuters, Consensus Metrix Department Stores & Off Price 3

4 We have developed four criteria, each pertaining to a critical industry headwind which we expect to re-shape the department store and Off Price space, to determine the retailers in our coverage universe that are leading the pack or lagging behind. Complete testing methodology can be found in the Appendix. Criterion I: Real Estate Portfolio Exposure: Industry Catalyst: Given the prevalence of retail store closings in the mall anchor group, the best positioned mall anchors are no longer the ones with the largest quantity of doors but rather possessing the highest quality doors. CS Analysis: Our Most Valuable Property (MVP) and Least Valuable Property (LVP) analysis evaluates which mall anchors have the most exposure to quality malls and strip centers within the US. Criterion II: Benchmarking Mobile ecommerce Capabilities: Industry Catalyst: Our analysis suggests ecommerce will generate the majority of sales and profit growth for the overall apparel industry over the next 10 years. With ecommerce penetration reaching 38% of total softlines sales by 2030, we believe investment in ecommerce is a baseline requirement for retailers looking to gain market share. CS Analysis: We compiled a comprehensive analysis of mobile website platform performance as a test of company ecommerce capabilities. Criterion III: Speed To Market and Reduced Markdown Risk Drive Share Capture Industry Catalyst: The efficiencies gained by running a retail operation with days of inventory versus days under the traditional broadline model reduces markdown risk, allowing more efficient retailers to lead on price while still maintaining adequate merchandise margins. We expect share capture for retailers with a structural supply chain speed advantage as a result. CS Analysis: We compare companies within our coverage universe based on the level of inventory intensity that they are able to run their operations under. We compare outstanding inventory to sales and not COGS given variances in accounting standard for COGS across our coverage (Occupancy, D&A, design, freight, duties may be included either in COGS or SG&A depending on company convention given a lack of GAAP standard for COGS.) Criterion IV: Unique Brand Portfolios Industry Catalyst: Power is increasingly in the hands of the brands, with mall anchors relying on upcoming brands to help drive relevance and traffic. While we believe wholesale as a distribution model is still necessary, we believe brand differentiation will help set apart mall anchors who are looking to attract consumers. CS Analysis: With our partner Quad Analytix, we analyzed the brand overlap and unique brand penetration for the four mall anchors to better understand if department stores really do have the brands consumers want to buy. Department Stores & Off Price 4

5 Assessing the State of the Industry The secular and cyclical headwinds facing both the broadlines and Off Price industries remain daunting, with potentially negative trends including consumer shifting spend to non-durable goods, ecommerce share shift accelerating, "deep value" retailers creating a deflationary environment, and declining share for footwear, accessories, and beauty ("FAB") categories after years of growth. We attempt to lay out key trends, with the following analysis: Market Share Shift Analysis Between Department Stores, Fast Fashion, and Off Price Sales-To-Inventory Level Positions Exiting 3Q16 Off Price Department Store Comp Trends FAB As A Percentage Of Sales For Department Stores Market Share Shifts: Off Price, Fast Fashion Win at the Expense of Department Stores Key Takeaway: Fast Fashion and Off Price are poised to take further market share from Department Stores. Our analysis of market share shifts over the last eight years shows fast fashion and Off Price retailers gaining share at the expense of a deteriorating department store environment. In that time period, specialty retail has gained 290bp of market share and Off Pricers have gained 700bp of market share. In contrast, department Stores have lost 990bp of market share. Department Store market share fell below 40% for the industry in 2012, and has continued to decline at an average rate of 150bp of share per year. Figure 4: Specialty Retail Has Overtaken Department Stores In Leading Retailer Market Share Figure 5: Department Store Market Share Has Fallen To 35% In 2015 From 45% In % 40% 30% 20% 10% 0% Retailer Market Share % 41.0% 38.1% 35.1% 23.9% 16.9% Specialty Retail Department Stores (ex Off Price) Off Price Department Store Market Share % 90% 80% 70% 60% 50% 40% 45.0% 43.2% 41.3% 30% 36.8% 35.1% 20% 10% 0% Department Stores (ex Off Price) Specialty Retail + Off Price Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Fast Fashion has played a critical role in taking market share away from department stores. We estimate that fast fashion has grown from 3.2% share to 7.7% share in the last eight years, with growth at H&M and Zara particularly driving much of the industry aggregate growth. With the entrance of Irish deep value retailer Primark into the US in 2016, we believe fast fashion is poised to be even more disruptive to the apparel sector, with department stores likely to be most affected. The retailers' extreme low prices on fashion basics will help reset consumer expectations for pricing across apparel retail, eroding pricing premiums and taking profits from department stores. Department Stores & Off Price 5

6 Figure 6: Fast Fashion Share Of Specialty Apparel Has Grown 450bp Since 2007 Fast Fashion Share of Specialty Apparel Figure 7: We Estimate Specialty Retail Growth Depends Heavily On European Fast Fashion Brands Fashion Retail 3 Year CAGR 3.2% 3.6% 3.8% 4.6% 4.9% 5.8% 6.0% 7.0% 7.7% 1.7% 9.5% 0.0% Source: Company data, Credit Suisse estimates Fashion Specialty H&M and Zara Growth ex H&M, Zara Source: Company data, Credit Suisse estimates Figure 8: With FAB Share Capture Likely Moderating, Fast Fashion Share Capture Could Further Accelerate Specialty Retailer Share Capture And Loss bp 365bp 307bp 84bp -168bp -338bp -705bp Fast Fashion Accessories Beauty Footwear Women's Fashion Teen Source: Company data, Credit Suisse estimates Sales-Inventory Position: Healthy Levels Are (Finally) Here Again Key Takeaway: Inventory positions remain below expected sales, suggesting potential for near-term gross margin recapture due to less markdown pressure. Department Stores and Off Pricers have successfully worked over the past three quarters to manage and clear the excess inventories from 3Q15 which resulted in excess markdown pressure through 1H16. For both sectors, sales-inventory positions inflected positively in exiting 2Q16, with further improvement in 3Q16 (department store inventories grew 4.0% below expected sales and Off Price inventories grew 7.1% below expected sales). With inventory growth below the rate of forward sales growth, we expect lower markdown risk, over the holiday period. As most department stores expressed conservative buying ahead of holiday, it is likely to set up an improving margin Y/Y. Department Stores & Off Price 6

7 Figure 9: Inventories Grew 4.0% Below Sales Figure 10: Inventories Grew 7.1% Below Sales 2CQ2011 4CQ2011 2CQ2012 Department Stores 2CQ2015 4CQ2014 2CQ2014 4CQ2013 2CQ2013 4CQ2012 4CQ2015 2CQ2016 4CQ % 10% 8% 6% 4% 2% 0% -2% -4% -6% 2CQ2011 4CQ2011 2CQ2012 Off Price Retail 4CQ2014 2CQ2014 4CQ2013 2CQ2013 4CQ2012 2CQ2015 4CQ2015 2CQ2016 4CQ % 25% 20% 15% 10% 5% 0% -5% -10% Sales Y/Y Growth Inventory Y/Y Growth Sales Y/Y Growth Inventory Y/Y Growth Source: Company data, Credit Suisse estimates, Thomson Reuters Source: Company data, Credit Suisse estimates, Thomson Reuters Off Price vs. Department Stores Comps Diverge For How Much Longer? Key Takeaway: A key risk to the multiple premium for Off Price is the eventual normalization of comp trends, which could occur should excess square footage growth for the sector deteriorate marginal productivity in the sector. We looked at the spread between comp store sales for the off price industry versus mall anchors to judge relative sector outperformance and underperformance. We found that Off Price comps have led mall anchors since the spread inflected positively in 2Q11 (21 consecutive quarters), with peak spread in 1Q16 (Off Price comps were up 5.2% versus mall anchor comps down -5.5%). With the spread growing from 1Q15 onwards and likely peaking in 1Q16, we expect a convergence back to the historical mean spread of 3.8%. Looking at the stock performance during this period, we see a low correlation (r 2 = 0.3) between the relative stock performance of mall anchor and Off Price and the comps trend. Mainly, since the first time the comps difference for the two sectors turned positive in 4Q11, it took another ~2 years at 3Q13 for the stock prices of Off Price sector to outperform those of mall anchors. Department Stores & Off Price 7

8 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 18 January 2017 Figure 11: Sales Weighted Off Price- Mall Anchors Comp Spread 12% Peak: 10.6% 10% 8% 6% 4% 2% Trough: -2.3% Mean: 3.8% 0% -2% -4% Source: Company data, Credit Suisse estimate, Companies include M, BONT, DDS, JCP, KSS, JWN, SSI, HBC,ROST,TJX,BURL, and SMRT Figure 12: Relative Stock Performance and Comps Comparison 12% 750% 9% 6% 3% 0% 550% 350% 150% -3% -50% 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 Sales Weighted Off Price - Mall Anchors Relative Stock Performance (Off Price - Mall Anchors) Source: Company data, Credit Suisse estimates, Thomson Reuters Department Store FAB Tailwind Has Ended Key Takeaway: FAB category moderation suggests Department Stores are losing one of the few offsets to negative secular industry trends. "FAB" categories (comprising footwear, accessories, and beauty) were crucial in driving sales growth for department stores between 2009 and We began to see moderation in category growth in 2014, when FAB sales growth failed to exceed overall industry sales growth. FAB sales failed to grow in 2015 in dollar terms and declined modestly in terms of percentage of total sales. We expect the trend to continue, with FAB category growth declining 3.3%, the first decline in six years, compared to expected overall industry sales decline of -1.4%. The growth of FAB categories has been a profound structural shift for department stores, particularly Macy's, Nordstrom and Dillard's, which were able to capitalize on this trend by adding new brands (such as Michael Kors in the handbag category) and targeted shop-in-shops. With expectations for FAB moderation, the group has likely lost one of its few offsets to the negative secular industry trends. Department Stores & Off Price 8

9 FAB Sales ($bn) FAB % of Sales 18 January 2017 Figure 13: 2015 Tipping Point: FAB Tailwind Appears Over for Mall Anchors "FAB" As A Percentage Of Sales $19.6 $19.0 $18.8 $20.4 $21.6 $22.8 $23.0 $23.7 $23.7 $ % 33% 32% 31% 30% 29% 28% E 27% FAB Sales (billions) FAB Exposure (% of Sales) Source: Company data, Credit Suisse estimates 2012 excludes 53rd week. Includes JWN, M, JCP, and KSS Department Stores & Off Price 9

10 Criterion I: Real Estate Portfolio Analysis: Who Are the Industry MVPs? Given the prevalence of retail store closings in the mall anchors group, intertwined with the fact that growth from FAB exposure is likely moderating, we revisit our Most Valuable Property (MVP) and Least Valuable Property (LVP) analysis to evaluate which mall anchors have the most exposure to quality malls within the US. Key Takeaways By Retailer: o o By Sector: o o Leaders: Nordstrom, Macy's (including Bloomingdale's) Laggards: JC Penney, Kohl s Leaders: Mid-Tier Department Stores, Premium Department Stores Laggards: Mass Channel, Off Price Nordstrom Best Positioned with the Highest Exposure To MVP Malls. Our analysis suggests that Nordstrom is the best positioned as a selective distribution channel for emerging brands as it has the highest percentage of its locations in MVP malls (64%, or 75 doors). JC Penney Worst Positioned with Highest Exposure To LVP Malls. JC Penney is in the most challenged position, with only 3% of their stores in MVP malls. Conversely, 12% of its stores are in LVP malls, the highest exposure in our analysis. Outlook For MVP Malls: Emphasizing Quality over Quantity. There is likely to be an increased focus on MVP malls and improving the quality and productivity of the existing store base. The shift in the mall anchors' role in developing emerging brands suggests that the best positioned mall anchors are no longer the ones with the largest quantity of doors but rather ones possessing the highest quality, which will allow brands to selectively expand while growing brand equity. Outlook For LVP Malls: The List Is Likely To Grow. As the industry evolves, the list of LVP malls could grow as more malls struggle to drive traffic as they lose tenants. These malls are likely prime candidates for further future store closures as retailers attempt to adjust their fixed cost base for permanently lower levels of brick & mortar sales as sales mix shifts to e-commerce. Store Rationalization Is a Work In Progress, Macy's Leading the Change. Historically, broadlines retailers have accounted for the majority of square footage closed in the retail industry. So far in 2016, 48% of square footage closures came from the broadlines sector. We believe that Macy's has been in front of the changing environment, with plans to close 100 stores over the next couple years, accounting for 15% to 20% of its store base. Off Price Square Footage Steadily Growing. In 2015, square footage for the sector grew 4.7%, the highest level of growth seen since Looking ahead to 4Q16, the sector is expected to continue its strong growth in terms of both square footage and sales. We see outsized Off Price square footage growth as the biggest risk to the Off Price sector, and consider this a crucial area for future research. Department Stores & Off Price 10

11 MVP and LVP Analysis Results Figure 14: Percent of Mall Anchor Retailer Total Locations in MVP Malls 64% 50% Figure 15: Percent of the 95 MVP Malls That Include Each Mall Anchor Retailer 82% 79% 35% 11% 3% 20% Nordstrom Bloomingdale's Macy's JCPenney Macy's Nordstrom JCPenney Bloomingdale's Source: Company data, Credit Suisse estimates, Source: Company data, Credit Suisse. NOTE: where Macy's has separate doors in the same mall (e.g. a separate furniture gallery or men's store), it was counted as just ONE location. Source: Company data, Credit Suisse estimates, NOTE: where Macy's has separate doors in the same mall (e.g. a separate furniture gallery or men's store), it was counted as just ONE location. Figure 16: Mall Anchors with Highest Exposure to MVP malls Mall Anchors # of Stores in "High Quality" Malls # Total Stores in US % of Total Stores in "High Quality Malls" % of "High Quality Malls" With This Tenant Nordstrom % 79% Bloomingdale's % 20% Macy's % 82% JCPenney 33 1,015 3% 35% Source: Company data, Credit Suisse. NOTE: where Macy's has separate doors in the same mall (e.g. a separate furniture gallery or men's store), it was counted as just ONE location. Mall Anchors: "Last Man Standing" Strategy Outlook for MVP Malls Historically, Mall Anchors Were Brand Gatekeepers. Mall anchors were the historical gatekeepers of softlines and many accessories brands. Emerging and established brands would strive for distribution with the mall anchors, seeking the largest quantity of doors, in part to establish a national presence. However, digital commerce is beginning to replace mall anchors as the first step in building brands and establishing brand equity. Still Key Distribution Channel, but Quality Over Quantity. Although department store's focused distribution may no longer be one of the first steps in building brand equity, this retail format still plays an important part in broadening distribution. As emerging brands mature, select department store doors can serve as a physical distribution channel, in lieu of owned retail stores or to supplement owned retail stores to reach new markets. This shift in the mall anchors' role in developing emerging brands suggests that the best positioned mall anchors are no longer the ones with the Department Stores & Off Price 11

12 largest quantity of doors but rather possessing the highest quality, which will allow brands to selectively expand while sustaining or even expanding brand equity. MVP Malls Have Highly Productive Tenants. While we do think that most mall anchors retailers have too many stores and that further store closures are necessary, we think that there is still significant value in high-quality locations. Given our lack of detailed sales productivity or traffic data on a location-by-location basis, we identified MVP malls as ones which share several "key tenants". 95 MVP Malls Identified. We filtered our mall anchor database (2,101 total malls) for malls that have at least half of these six "key tenants," which resulted in 95 malls that we label as MVP malls. These tenants are more selective in their brick & mortar presence and therefore tend to be located mainly in malls with strong traffic and elevated sales per square footage: Nordstrom, lululemon, Apple, Louis Vuitton, Tiffany, and Cheesecake Factory. These tenants also tend to complement one another by providing a broad range of lifestyle offerings, creating a destination experience. Outlook For LVP Malls LVP Malls Defined As Those Most Immediately Distressed. We defined LVP malls as those with mortgages in four distressed categories, which tend to occur when a mall has lost (or will lose) a major tenant. The prime reason for this happening is low sales productivity, making it difficult for the tenant to generate a four-wall profit. 184 LVP Malls Identified. We cross referenced the list of distressed retail properties with our mall anchor database, resulting in a list of 184 LVP malls with at least one of the following tenants: Bon-Ton, Dillard's, JC Penney, Nordstrom, Macy's, and Sear's. These 184 locations appear to be malls that are in the most immediate jeopardy, although we note it does not represent the complete list of distressed properties in the intermediate or longer term. We Estimate LVP Malls Generate 30-40% of the Total Sales of MVP Malls. While we do not know the sales productivity levels of each specific mall, the distressed mortgage status of these properties implies they are unattractive C-level properties. We identified almost twice as many LVP malls as MVP malls, but we estimate that these LVP malls, in aggregate, generate only roughly 30-40% of the total sales volume generated by the identified MVP malls. This is based on estimates that MVP malls are estimated to have 3 times the sales productivity as LVP malls on a per square foot basis, according to data from the International Council of Shopping Center, and also that MVP malls are 1.8 times larger than LVP malls on a per unit basis. Figure 17: Mall Anchors: Percentage of Locations in LVP versus MVP Malls Bloomingdale's 50% Nordstrom 3% 64% Macy's 11% 11% JCPenney 12% 3% Source: Company data, Credit Suisse estimates 0% 20% 40% 60% 80% 100% % in "LVP" Malls % in Other Malls % in "MVP" Malls Department Stores & Off Price 12

13 Units Closed 18 January 2017 Figure 18: MVP Versus LVP Malls In Terms of Units, Size, Productivity, and Total Sales Source: Credit Suisse research Retail Store Closings: 48% Of 2016 Closings from Broadlines on a Sq Ft Basis As Rationalization Efforts Take Shape Year to date, industry retailers have announced the closing of 1,956 retail stores, which is approximately 40% lower than 2015's year-to-date number. Since we started tracking the store closings in 1995, 2015 represents the second highest level of closings, only below the 2008 peak number of 6,163 closures. Note that these figures include all retailers that have publicly announced domestic store closings, not only for the companies covered in our universe; not all closures necessarily occur in the year announced. Figure 19: Domestic Retail Store Closings Announcements Peaked In 2015 Retail Units Closure Announcements in FY 7,000 6,000 5,000 4,000 3,000 2,000 1,704 1,343 2,795 6,163 4,442 3,917 2,480 2,140 1,766 3,084 5,077 1,986 1,000 0 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 Source: Company data, Credit Suisse estimates On a square footage basis, only 43.4M square feet were closed in 2015, compared to 73.2M square feet in In 2016, 81.4M square feet have been announced to close date. This is the highest level since Some of the biggest closing announcements this year include 100 store closings from Macy's, closing all stores from Sports Authority, and store closings from mass merchants like Walmart and Kmart. Department Stores & Off Price 13

14 Historically, broadlines retailers have accounted for the majority of square footage closed in the retail industry. However, in 2015, contribution from broadlines declined to 34%, from 56% in So far in 2016, 94% of store closures are either from the broadlines and hardlines sectors on a square footage basis. Figure 20: On a Square Footage Closure Basis, 2016 Is On Track To Have the Highest Level in Eight Years Square Footage Closed (M) Square Footage (mn's) YTD Retail Sq Ft Closure Announcements in FY '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 Source: Company data, Credit Suisse estimates Figure 21: 48% Of Total 2016 Square Footage Reduction Has Come from Broadlines Square Footage Closed, by Sector Broadlines Hardlines Softlines Food & Drug Source: Company data, Credit Suisse estimates Macy's Rationalization Plan Leads the Pack We believe that Macy's have been in front of the changing and challenging environment for retail locations amongst the mall anchors. Macy's recently announced 68 store closing by year end (of an expected 100 total store closures),which will account for 15-20% of its store base. Mall anchors are likely to continue to rationalize their store base, and the impact could extend to further closings of malls themselves. Department Stores & Off Price 14

15 % Y/Y Square Footage / % Y/Y Sales 18 January 2017 Figure 22: Macy's Has Made the Biggest Strides in Store Fleet Rationalization from Peak Levels JCP JWN** KSS** M*** Total , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , E 1, , , E 1, , ,880 JCP JWN** KSS** M*** Peak Year E Reduction from Peak % Reduction -9% -2% -1% -12% Source: Company data, Credit Suisse estimates **M, JWN, KSS: full-line stores only ***2004 M reflects pro-forma store count for MAY of 491 stores Off Price: Steadily Growing Square Footage In 2015, square footage for the sector grew 4.7%, the highest level of growth seen since '08. Alongside the physical growth of the sector, sales productivity improved as well, resulting in total sales growth of 7.7%. Looking ahead to 4Q16, the sector is expected to continue its strong growth in terms of both square footage and sales. We believe that outsized square footage growth for Off Price is the biggest risk to the return and multiple profile of the Off Price channel looking forwards. Figure 23: Square Footage Growth To Remain Elevated in % 8% 7% 0.9% 6% 5% 4% 3% 0.5% 1.3% 1.4% 2% 1% 0% -1% Defunct Retailers TJX - MarMaxx Ross Stores Burlington Stores Stein Mart "Emerging" Off-Pricers Net Sales Y/Y % Growth Source: Company data, Credit Suisse estimates Department Stores & Off Price 15

16 Criterion II: Mobile Commerce Analysis: Who Is Best Positioned To Win the Race Online? We compiled a comprehensive analysis of website platform performance given our increasing conviction that ecommerce is the dominant apparel industry growth vehicle. In order to determine which retailers are truly ahead of the digital curve, we took our analysis a step beyond the desktop and analyzed the mobile website of 13 retailers, evaluating qualitative platform performance (based on 19 points of criteria) and mobile site speed (based on 10 points of criteria). Our analysis of ecommerce and brick-and-mortar growth suggests that the industry has reached a watershed moment, with ecommerce generating more than 50% of sales and profit growth for the overall apparel industry. With ecommerce penetration expected to approach 38% of total softlines industry sales by 2030, we believe retailers that have an already well established mobile commerce strategy will be at a structural advantage. For the full list of our testing methodology and criteria, please refer to the Appendix. Key Takeaways By Brand: o Leaders: Macy's, Bloomingdales, JC Penney, Kohl's, Anthropologie, Urban Outfitters, Nordstrom Rack, Free People o Laggards: Nordstrom, Burlington Coat Factory, TJ Maxx, Marshalls, Ross Dress For Less By Sector: o o Leaders: Mid-Tier Department Stores, Mass Channel Laggards: Premium Department Stores, Off Price Key Qualitative Takeaways: o o o o Functionality: Simplicity Wins: The mobile websites that performed the best were simple, intuitive to navigate, and easy to buy product from. Omni-channel Capabilities: Mass channel and premium department stores led all categories in this area, with mid-tier department stores and Off Pricers lagging. As consumers increasingly want flexibility, these options should provide an opportunity for brick-and-mortar to be more effective as foot traffic continues to decline. Ease of Checkout: The most efficient site (Nordstrom and Nordstrom Rack) took 2 pages to checkout versus 8 pages for the worst-in-class site (Urban Outfitters). We believe checkout process is a key pain point for consumers, which is likely magnified on the small screen of mobile devices. Shipping and Returns: 92% of retailers either require a minimum order for free shipping or charge a fee. Policies that cost consumers money and make returning items difficult may impact the lifetime value of a customer. Key Speed Takeaways: o Speed Is Crucial: The most surprising part of the analysis was seeing how slow sites were on mobile devices compared to desktops. Mobile sites averaged a score of 60%, compared to the average desktop score of 69%. We believe slow speeds likely lead to site and cart abandonment. Department Stores & Off Price 16

17 Mobile Testing Results Figure 24: Total CS Mobile Rankings by Category CS Total Mobile Testing Score By Category 81% 79% 72% 72% 57% Mid-Tier Department Store Mass Channel Average Premium Department Store Off Price Source: Credit Suisse Research, Google Brand/Retailer CS TOTAL Mobile Score Mid-Tier Department Store 81% Mass Channel 79% Average 72% Premium Department Store 72% Off Price 57% Figure 25: Total CS Mobile Rankings By Retailers Brand/Retailer CS TOTAL Mobile Score Macy's 81% Bloomingdales 80% JC Penney 79% Kohl's 78% Anthropologie 71% Urban Outfitters 70% Nordstrom Rack 68% Free People 67% Average 67% Nordstrom 63% Burlington Coat Factory 63% TJ Maxx 58% Marshalls 48% Ross Dress For Less 46% Figure 26: Total CS Mobile Rankings By Retailers Ross Dress For Less Marshalls TJ Maxx Burlington Coat Nordstrom Average Free People Nordstrom Rack Urban Outfitters Anthropologie Kohl's JC Penney Bloomingdales Macy's CS Total Mobile Testing Score 46% 48% 58% 63% 63% 67% 67% 68% 70% 71% 78% 79% 80% 81% Source: Credit Suisse Research, Google Source: Credit Suisse Research, Google Department Stores & Off Price 17

18 Qualitative Testing Results Figure 27: CS Qualitative Scores By Retailers Brand/Retailer Qualitative Score JC Penney 88% Macy's 82% Bloomingdales 82% Anthropologie 82% Kohl's 79% Urban Outfitters 79% Nordstrom 76% Nordstrom Rack 74% Burlington Coat Factory 74% Free People 74% Average 73% TJ Maxx 68% Marshalls 44% Ross Dress For Less 44% Figure 28: CS Qualitative Scores By Retailers Ross Dress For Less Marshalls TJ Maxx Average Free People Burlington Coat Factory Nordstrom Rack Nordstrom Urban Outfitters Kohl's Anthropologie Bloomingdales Macy's JC Penney CS Qualitative Mobile Platform Score 44% 44% 68% 73% 74% 74% 74% 76% 79% 79% 82% 82% 82% 88% Source: Credit Suisse Research Source: Credit Suisse Research Speed Score Testing Results Figure 29: CS Speed Scores By Retailers Brand/Retailer Mobile Speed Score Macy's 79% Kohl's 77% Bloomingdales 76% JC Penney 65% Nordstrom Rack 60% Average 59% Free People 58% Urban Outfitters 56% Marshalls 55% Anthropologie 55% Ross Dress For Less 50% Burlington Coat Factory 47% Nordstrom 43% TJ Maxx 43% Source: Credit Suisse Research, Google Figure 30: CS Speed Scores By Retailers TJ Maxx Nordstrom Burlington Coat Factory Ross Dress For Less Anthropologie Marshalls Urban Outfitters Free People Average Nordstrom Rack JC Penney Bloomingdales Kohl's Macy's Source: Credit Suisse Research, Google CS Mobile Speed Score 43% 43% 47% 50% 55% 55% 56% 58% 59% 60% 65% 76% 77% 79% Department Stores & Off Price 18

19 Deep Dive on Key Qualitative Mobile Commerce Testing Metrics Omni-channel Capabilities We believe an important cornerstone of ecommerce success is integrated, seamless inventory. Historically, companies added their ecommerce channel as a siloed account from the Retail channel. ecommerce was set up as its own account with its own distribution. One of the first, most significant investments traditional companies have made is integrating IT systems and distribution to create the ability to locate product across both ecommerce and retail channels in order to efficiently fulfill consumer demand across both. We looked across retailer's mobile websites to identify who has integrated inventory built into their ecommerce platform for the consumer to see (the ability to see if product online is also available in nearby stores), as well as who has buy online/pick up in store within 24 hours. We believe consumers increasingly want flexibility and these options should provide an opportunity for brick-and-mortar to be used more effectively as spur-of-themoment foot traffic continues to decline. Our analysis showed that Mass Channel (100%), Mid-tier department stores (100%) led all categories in this area, with Premium Department Stores (60%) and Off Pricers (17%) lagging. Figure 31: 46% Of Retailers in Our Analysis Have Online Visibility and Pick Up Options Source: Credit Suisse Research Ecommerce/Store Inventory Visibility Buy Online/ Pick Up In Store Within 24 Hours JC Penney YES YES Kohls YES YES Nordstrom YES YES Nordstrom Rack NO NO Macy's YES YES Bloomingdales YES YES Urban Outfitters YES YES Anthropologie YES NO Free People YES NO TJ Maxx NO NO Marshalls N/A N/A Burlington Coat Factory NO NO Ross Dress For Less N/A N/A Mobile Applications We believe mobile applications ("Apps") create a more convenient, seamless shopping experience for consumers on mobile devices. However, we were surprised at how many retailers do not have Apps, as 4 out of 13 did not have an App at all. In our view, one of the biggest obstacles for App use is the lack of returning customers. The App is not worth maintaining if customers download but never use. We believe brands with the highest App customer retention, or Daily Active Users (DAUs), also offer best-inclass loyalty programs or other benefits (like Amazon Prime) that perpetuate consistent return trips. We believe companies will work to integrate features into their platforms to drive App traffic. Department Stores & Off Price 19

20 Figure 32: 69% Of Broadlines and Off Price Retailers Offer Mobile Apps Broadlines Mobile App Availability Figure 33: Off Pricers Lag In Mobile App Penetration Mobile App Availability By Category 100% 100% 100% No Mobile App, 31% 20% Mobile App Available, 69% Premium Department Store Mass Channel Mid-Tier Department Store Off Price Source: Credit Suisse Research Source: Credit Suisse Research Steps to Checkout We think that a key pain point for consumers is the checkout process, which can be magnified on the small screen of mobile devices. We believe the odds of cart abandonment likely increase with each page that has to load before the checkout process is complete. In our study, the most efficient sites took only 2 pages to checkout versus 8 pages for the worst-in-class sites (group average was 4.4 pages). Some of the common check-out disruptions we found include: Using an extra page to enter your address in order to checkout as a guest Enter shipping and billing separately, with no way to select to duplicate fields Using an extra page for delivery options when those options can at least be consolidated to the shipping page Entering City, State, and Zip code for shipping and billing address when City and State and be auto filled using the zip code only Pop-ups on checkout page trying to get you to buy other products, which inhibit customers from trying to purchase the products already in their cart Not having customer service/support info readily available (one-click) on checkout pages Department Stores & Off Price 20

21 Figure 34: Mobile Checkout Analysis 2 2 Steps To Mobile Checkout Source: Credit Suisse Research Shipping and Return Policy Figure 35: Shipping And Returns Policy Scores We believe shipping and return policies can be a significant differentiator among companies, with consumers increasingly expecting not to pay for shipping in either direction. We analyzed the policies for each brand/retailer and allocated points based on (1) payments for shipping (excluding promos); (2) payments for returns (excluding promos); and (3) flexibility of returns. Best-in-class retailers were Bloomingdales, which provided free shipping with no minimum, and Bloomingdales and Urban Outfitters which provided free returns. Worst-inclass in our analysis were TJ Maxx and Burlington Coat Factory who offered no free shipping minimum and no free returns. Shipping & Returns Scores 83% 83% 83% 50% 50% 50% 59% 67% 67% 67% 67% 67% 17% 17% Source: Credit Suisse Research Department Stores & Off Price 21

22 Figure 36: Shipping Policies Brand/Retailer Shipping Policy Excluding Promotions Score Nordstrom Free standard shipping on all orders (3-6 days) BEST JC Penney Free standard shipping after spending $50 (3-5 days) Urban Outfitters Free standard shipping after spending $50 (3-5 days) Kohls Free standard shipping after spending $75 (3-6 days) Macy's Free standard shipping after spending $99 (3-6 days) GOOD Nordstrom Rack Free standard shipping on orders over $100 (3-6 days) Free People Free standard shipping on orders over $100 (3-5 days) Bloomingdales Free standard shipping over $150; $6-13 fees before the minimum TJ Maxx $9-10 standard shipping fee (5-10 days) Burlington Coat Factory Standard shipping fee from $8-100 based on size of order FAIR Anthropologie Standard shipping fee from $7-20 based on size of order Marshalls N/A Ross Dress For Less N/A POOR Source: Credit Suisse Research Figure 37: Returns Policies Source: Credit Suisse Research Free Returns? Brand/Retailer Online In- Store JC Penney No Yes Kohls No Yes Nordstrom No Yes Nordstrom Rack No Yes Macy's No Yes Bloomingdales Yes Yes Urban Outfitters Yes Yes Free People No Yes Anthropologie No Yes TJ Maxx No Yes Marshalls N/A Yes Burlington Coat Factory No Yes Ross Dress For Less N/A Yes Department Stores & Off Price 22

23 Apparel Industry Growth Increasingly Fueled by ecommerce Over Brick and Mortar Our analysis of e-commerce and brick-and-mortar growth suggests that the industry has reached a watershed moment, with ecommerce generating more than 50% of sales and profit growth for the overall apparel industry. Analysis of U.S. Census Bureau data on ecommerce sales and extrapolation of recent growth trends across the softlines industry suggests that over the next 15 years, the overall softlines industry in the United States: Could grow to $390B in revenue from $340B Can sustain a 1.4% CAGR from However, growth will not be distributed evenly. We believe that ecommerce: Has potential to approach 37.5% of total softlines industry sales Could generate $94B in incremental revenue Can sustain a multi-year CAGR of 7%. Brick and mortar stores, on the other hand: Could fall to 62.5% of total industry sales Could give up $19B in total sales volume Grow at a multi-year CAGR of -0.5%. We believe brands that start online will be a primary beneficiary of this structural spending shift. We also see opportunity for online brand aggregators as well as traditional brands capable of converting their messaging and sales channels away from mass marketing into the new consumer-first digital realm. Figure 38: Softlines Sales CAGR by Channel Softlines Industry Sales CAGR 7.1% 1.4% -0.5% US Softlines Sales US Brick and Mortar US ecommerce Figure 39: Estimated Softlines Penetration by 2030 Will Reach 38% of Industry Sales 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Softlines ecommerce Penetration 0.8% 3.3% 8.4% 16.7% 25.3% 32.6% 37.5% E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E 2030E Source: Credit Suisse estimates, US Census Bureau Data Source: Credit Suisse estimates, US Census Bureau Data Department Stores & Off Price 23

24 Estimated Historical ecommerce Penetration Figure 40: Mall Anchors' Estimated ecommerce Penetration Company E BONT DDS JCP 1,523 1,020 1,079 1,225 1,386 1,525 JWN Full Line 913 1,269 1,622 1,996 2,300 2,427 KSS 1,012 1,444 1,730 2,124 2,517 2,643 M (ex. Off-Price) 1,951 2,750 3,725 4,107 4,682 4,916 SSI Total 5,633 6,802 8,558 9,945 11,446 12,099 Company E BONT 2.4% 3.3% 4.8% 6.1% 7.0% 7.5% DDS 2.4% 3.1% 3.7% 4.5% 5.1% 5.5% JCP 8.8% 7.9% 9.1% 10.0% 11.0% 12.1% JWN Full Line 10.8% 13.7% 17.4% 20.6% 23.2% 25.1% KSS 5.4% 7.5% 9.1% 11.2% 13.1% 14.1% M (ex. Off-Price) 7.4% 10.0% 13.4% 14.7% 17.4% 19.4% SSI 0.9% 1.4% 1.8% 2.3% 2.8% 3.2% Total 6.92% 8.49% 10.85% 12.46% 14.43% 15.77% Source: Company data, Credit Suisse estimates Figure 41: Off Price Estimated ecommerce Penetration Company E ROST SMRT JWN Rack/Hautelook Total Company E ROST 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% SMRT 0.0% 0.0% 0.4% 1.0% 1.7% 2.1% JWN Rack/Hautelook 7.0% 8.8% 9.7% 10.1% 13.1% 13.3% Total 1.28% 1.73% 2.07% 2.34% 3.20% 3.33% Source: Company data, Credit Suisse estimates Department Stores & Off Price 24

25 Criterion III: Speed To Market and Inventory Intensity The efficiencies gained by running a retail operation with days of inventory versus days under the traditional broadline model reduces markdown risk, allowing more efficient retailers to lead on price while maintaining adequate merchandise margins. We expect share capture for retailers with a structural supply chain speed advantage as a result. We have compared companies within our coverage universe based on the level of inventory intensity under which they are able to run operations. We compare outstanding inventory to sales rather than COGS given variances in accounting standard for COGS across our coverage (Occupancy, D&A, design, freight, duties may be included either in COGS or SG&A depending on company convention given a lack of GAAP standard for COGS). Key Takeaways By Retailer: o o By Sector: o o Leaders: Ross Stores, TJ Maxx, Burlington Stores, Urban Outfitters, Nordstrom Laggards: JC Penney, Kohl's, Macy's Leaders: Off Price, Premium Department Stores Laggards: Mid-Tier Department Stores, Mass Channel Burlington Stores, Urban Outfitters Have Made The Most Progress. On a fourquarter rolling average basis, Burlington Stores and Urban Outfitters have made the most progress over the past two years in moving toward more efficient inventory management. Burlington's inventory to sales ratio has improved by 710bp and Urban Outfitters's inventory to sales ratio has improved by 340bp. This is compared to an average flat improvement for the group. Nordstrom Inventory/Sales Leads Mall Anchors, In-Line with Off Pricers. Nordstrom leads the Mall Anchor group significantly, with a four-quarter rolling average inventory to sales ratio of 0.60 exiting 3Q16, well below the mall anchor group average of This ratio is more in-line with the Off Price four-quarter rolling average inventory to sales ratio of We believe Nordstrom is best positioned to run a more efficient inventory model, and reduce markdown risk, when compared to its competitors. Off Pricers Running Efficient Models. We believe the Off Pricers have created a structural advantage with their inventory operation amongst apparel retailers, with a four-quarter rolling average inventory to sales ratio of 0.52 for the group, compared to 0.87 for the department stores. We expect some share capture to continue for Off Pricers as a result of this advantage. Fast Fashion Has Disrupted the Historical Supply Chain Model. The Fast Fashion model is not as collection driven as the traditional model, but is an ongoing cycle of fashion replenishment (more breadth and less depth), in order to keep fresh styles rotating through stores. Fast Fashion retailers have thus been able to flood the market with new, inexpensive styles, and have been able to react quicker to changes in consumer preferences. Department Stores & Off Price 25

26 Inventory/Sales Analysis Figure 42: BURL, URBN Have Made the Most Progress in Working Toward Leaner Inventories; M Lags the Group Considerably Inventory/Sales Change Over Time Exiting Current Quarter 4Q Rolling Average 3Q16 3Q15 3Q14 2 yr Δ 3Q16 3Q15 3Q14 2 yr Δ BURL bp bp URBN bp bp JCP bp bp KSS bp bp ROST bp bp TJX bp bp JWN bp bp M bp bp Source: Company data, Credit Suisse estimates Figure 43: Mall Anchors Days of Inventory JWN Runs Significantly Leaner Inventories Compared To Peers Mall Anchors Days of Inventory Rolling 4-quarter Average Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 JWN JCP KSS M URBN Source: Company data, Credit Suisse estimates Figure 44: Off Pricer Days of Inventory BURL Is Working To Catch Up with Peers 70 Off Price Days of Inventory Rolling 4-quarter Average Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 TJX ROST BURL Source: Company data, Credit Suisse estimates Department Stores & Off Price 26

27 Figure 45: Mall Anchors Vs. Off Pricers Inventory/Sales Divergence Is Clear 80 Off Pricer Vs Mall Anchors Rolling 4-quarter Average Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 Off Price Days of Inventory Mall Anchors Days of Inventory Source: Company data, Credit Suisse estimates Fast Fashion Model vs. Traditional Model Key To Fast Fashion Disruption Is the Revolutionized Supply Chain Model. The Fast Fashion model focuses more on a "make, not create" philosophy. Base materials are bought up front and versions of best-selling styles are produced in these existing fabric groups. The Fast Fashion model is not as collection driven as the traditional model, but is an ongoing cycle of fashion replenishment (more breadth and less depth), in order to keep fresh styles rotating through stores. Fast Fashion retailers have thus been able to flood the market with new, inexpensive styles, and have been able to react quicker to changes in consumer preferences. Some US Retailers Already Ahead of Department Stores. The last five year, there has been a dramatic rise of retailers in the U.S. with responsive supply chains (Forever 21, L Brand's Victoria's Secret and Bath & Body Works etc.). These retailers have design and production windows that are measured in days or weeks not months, which has allowed new market entrants to establish where demand is likely to be (via test and react procedures and fast following), and produce products at lower AUR, and lower initial margin given lower risk of markdown for off-trend styles. This has led to further erosion of the consumer's tolerance for high initial price points at high merchandise margin. With department stores on the traditional 12-month supply chain model, we believe they are increasingly at a structural disadvantage to their fast fashion peers. Merchandiser driven, not design driven Key Differences Item based, not collection based Continuous cycle, not linear process Interweaving versus more compartmentalized departmental structure Core fabric bought up front and designed into, not seasonally or on one-time basis Department Stores & Off Price 27

28 Figure 46: Fast Fashion Supply Chain Model Bring Product To The Sales Floor In 50-66% Of The Time Of Traditional Supply Chain Models FAST FASHION MODEL CORE MATERIALS ALREADY ON HAND SELECT BEST SELLING STYLES 4 WEEKS BOAT 6 WEEKS FINALIZE SPEC 2 WEEKS weeks AIR 1 WEEK MATERIALS/ SPEC REC'D 2 WEEK MAKE 4-6 WEEKS Source: Credit Suisse research Department Stores & Off Price 28

29 Criterion IV: Brand Portfolio Analysis: Do Retailers Really Have the Brands Consumers Want? With our partner Quad Analytix, we analyzed the brand overlap and unique brand penetration for the four mall anchors to attempt to answer the question if department stores really do have the brands consumers want to buy. Power is increasingly in the hands of the brands, with mall anchors relying on upcoming brands to help drive relevance and traffic. While we believe wholesale as a distribution model is still necessary, we believe brand differentiation will help set apart mall anchors who are looking to attract consumers. Key Takeaways By Retailer: o o By Sector: o o Leaders: Nordstrom, Urban Outfitters Laggards: Macy's, JC Penney Leaders: Premium Department Stores, Off Price Laggards: Mass Channel, Mid-Tier Department Stores Nordstrom Clear Leader in Brand Portfolio Distinctiveness. In our analysis, Nordstrom easily led all other mall anchors in offering consumers a deep range of brands which are not replicated at other retailers. With 679 unique brands in Women's Apparel and 291 unique brands in Men's Apparel, the company held 48% of the unique brands identified in our analysis. We note the Urban Outfitters brands have also developed several exclusive brands and collections (partnerships with Calvin Klein, adidas, FILA; Free People Beach, Summer, and One Collections). Some Brands Are Ubiquitous. Nike, Levi's, adidas, Columbia, and Disney were the five brands we identified at all four mall anchors, suggesting retailers may not be able to depend on these brands as unique offerings. Nike and Levi's in particular also had the greatest shelf space in aggregate across all retailers in our analysis a healthy distribution sign for both brands, but not necessarily a point of differentiation for department stores to attract consumers. Growing Private Label Not Necessarily a Good Thing. We prefer retailers increasing penetration of exclusive brands, rather than private label brands. We believe that since retailers do not invest behind private label brands the way that third-party brands do, they are less likely to build consumer brand preference or brand loyalty. Investments behind exclusive brands (such as Nordstrom's Topshop and Bonobos or Urban Outfitter's investment in local designers) are more likely to pull consumers. Off Pricers Have Minimized Private Label. Private label brands have historically had little to no penetration in the Off Price model, with Off Pricers focusing providing value on products from the national brands which consumers prefer. Work In Progress: Department Stores Adjusting To the New Online Brand Paradigm. We believe the online revolution represents a shift in brand building away from the traditional model, with power is in the hands of the brands now more than ever. Department stores are increasingly relying on new, upcoming brands to help drive relevance and traffic into their doors. That said, while we believe wholesale as a distribution model is still relevant and necessary, the traditional models are transitioning to fit into the new reality. Wholesale distribution still offers the greatest convenience to consumers in the form of a one-stop-shopping marketplace. Department Stores & Off Price 29

30 Digital Brand Acquisitions. Traditional indirect-to-consumer retailers have been working to streamline distribution infrastructure and enhance website platforms in order to accommodate the shift in spending. We note Nordstrom leads the way in identifying and integrating new online brands as part of their digital strategy, with the acquisitions of HauteLook and Trunk Club, as well as investments in Bonobos, BaubleBar, and Shoes of Prey. Brands Unique To One Retailer Figure 47: Nordstrom Has the Most Unique Brands, JC Penney the Least Number Of Unique Brands By Category Macy's JC Penney Kohl's Nordstrom 95 Women's Apparel Men's Apparel Women's Accessories Men's Accessories Source: Credit Suisse Research, Quad Analytix Figure 48: Percentage Of Unique Brands by Retailer Macy's, 15.8% JC Penney, 5.5% Nordstrom, 47.8% Kohl's, 30.9% Source: Credit Suisse Research, Quad Analytix Department Stores & Off Price 30

31 Figure 49: Unique Brand Shelf Share for JC Penney 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 16.1% JC Penney: Men's Apparel Top Unique Brands Shelf Share 6.7% 4.7% 4.5% 4.1% Stafford Arizona Classic St. John's Bay Michael Strahan 2.8% JF J. Ferrar 2.2% 2.0% Red Kap Claiborne U.S. Polo Assn. 1.5% 1.5% The Foundry Supply Co. JC Penney: Women's Apparel Top Unique Brands Shelf Share 14% 12% 10% 11.6% 10.8% 9.8% 9.3% 8% 6% 4% 2% 6.1% 5.1% 4.5% 3.0% 2.5% 2.0% 0% Source: Credit Suisse Research, Quad Analytix Figure 50: Unique Brand Shelf Share for Kohl's 14% 12% 10% 8% 11.8% Kohl's: Men's Apparel Top Unique Brands Shelf Share 6% 4% 4.2% 3.6% 2.6% 2.5% 2% 1.5% 1.5% 1.3% 1.2% 1.1% 0% Croft & Barrow Chaps Apt. 9 Sonoma Campus Heritage Urban Pipeline Marc Anthony Grand Slam Fila Tek Gear 7% 6% 6.5% Kohl's: Women's Apparel Top Unique Brands Shelf Share 5.8% 5% 4.4% 4% 3% 2% 2.9% 2.9% 2.2% 2.0% 1.9% 1.8% 1.7% 1% 0% Croft & Barrow Apt. 9 Sonoma Chaps SO Jennifer Lopez Affinitas Tek Gear Dana Glamorise Buchman Source: Credit Suisse Research, Quad Analytix Department Stores & Off Price 31

32 Figure 51: Unique Brand Shelf Share for Macy's 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 4.2% Macy's: Men's Apparel Top Unique Brands Shelf Share 3.6% 3.4% 3.0% 2.7% 2.2% 2.1% 2.0% 1.8% 1.7% 5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Macy's: Women's Apparel Top Unique Brands Shelf Share 4.7% 4.7% 4.2% 3.1% 3.0% 2.4% 2.2% 1.9% 1.6% 1.6% Source: Credit Suisse Research, Quad Analytix Figure 52: Unique Brand Shelf Share for Nordstrom 80% 70% 60% 50% 40% 30% 20% 10% 0% 76.1% Nordstrom: Men's Apparel Top Unique Brand Shelf Share 3.1% 0.8% 0.6% 0.6% 0.6% 0.5% 0.5% 0.4% 0.3% 3.0% 2.5% 2.5% Nordstrom: Women's Apparel Top Unique Brands Shelf Share 2.0% 1.5% 1.0% 1.5% 1.5% 1.4% 1.1% 1.0% 0.9% 0.9% 0.8% 0.8% 0.5% 0.0% Topshop Halogen Eliza J St. John Chantelle Paige Caslon Nic + Zoe Vince Zella Collection Source: Credit Suisse Research, Quad Analytix Department Stores & Off Price 32

33 Brand Overlap Analysis Some brands have become ubiquitous across the mall anchor space, as multiple mall anchors carry products for both men and women. We identify Nike as the brand with the greatest overlap, as it is available at JC Penney, Kohl's, Macy's, and Nordstrom for both men and women. Levi's, the denim brand, comes second, as it is available at all four retailers as well. Figure 53: Nike And Levi's Product Have the Greatest Breadth Across Retailers and Depth of Shelf Top Men's Apparel Brands Across Mall Anchors Shelf Share * Merchant Count Nike Levi's Dockers Adidas Izod Haggar Van Heusen Rakph Lauren Columbia Champion Top Women's Apparel Brands Across Mall Anchors Shelf Share * Merchant Count Nike Levi's Lee Calvin Klein Jockey Adidas Columbia Ralph Lauren Dickies Disney Source: Credit Suisse Research, Quad Analytix Figure 54: Nike, Levis, adidas, Columbia, And Disney Product Can Be Found At Every Mall Anchor Category Brand JC Penney Shelf Share Kohl's Shelf Share Macy's Shelf Share Nordstrom Shelf Share Men's Accessories Nike 15.09% 2.81% 4.78% 1.61% Nike 2.97% 3.93% 8.00% 0.38% Men's Apparel Levi's 6.52% 5.85% 1.84% 0.00% adidas 1.24% 1.79% 2.89% 0.09% Nike 1.59% 1.96% 2.25% 0.48% Levi's 2.71% 1.52% 0.62% 0.00% Women's Apparel adidas 0.47% 0.58% 0.57% 0.24% Columbia 0.04% 0.99% 0.05% 0.10% Disney 0.02% 0.01% 0.01% 0.00% Source: Credit Suisse Research, Quad Analytix Department Stores & Off Price 33

34 The methodology for these brand overlap scores can be found in the appendix section of this note. Transition To the New Wholesale-Brand Paradigm We believe the online revolution represents a shift in brand building away from the traditional model. Power is in the hands of the brands now more than ever, with wholesalers like department stores increasingly relying on new, upcoming brands to help drive relevance and traffic into their doors. That said, while we believe wholesale as a distribution model is still relevant and necessary, the traditional models are transitioning to fit into the new reality. Wholesale distribution still offers the greatest convenience to consumers in the form of a one-stop-shopping marketplace. Figure 55: Traditional Brand Building Model Vs. New Model Source: Credit Suisse Research Investments in Online-Only Brands Traditional indirect-to-consumer retailers have been working to streamline distribution infrastructure and enhance website platforms in order to accommodate the shift in spending. Retailers from Macy's to Wal-Mart are focused on ecommerce efforts to make products available and transactions more efficient. Below, we list examples of recent investments and acquisitions of online-only brands by broadline retailers to expand or deepen their digital capabilities. We note Nordstrom continues to lead the way in identifying and integrating new online brands as part of their digital strategy. Department Stores & Off Price 34