Retail Earnings Raises Red Flag

Edited by Vani Rao

Retailers miss earnings expectations owing to harsh winter weather

shutterstock_127396400The current earnings season is nearing its end, but there were still plenty of big names reporting quarterly results last week in the retail sector. Retailers always attract a lot of attention from Wall Street since consumer spending plays such an important role in gauging the overall health of the economy.

Investors were hoping key retailers could buck the nasty weather that hit the nation earlier in the year. But earnings misses by retailers ranging from Wal-Mart Stores Inc. (NYSE:WMT), Sears Holdings (NASDAQ:SHLD), Staples Inc. (NASDAQ:SPLS), and Urban Outfitters (NASDAQ:URBN) were not encouraging.

Disappointing results from retailers were especially troublesome because investors were hoping for good returns. Analysts expected 8.2% earnings growth in Q1 from the Consumer Discretionary sector, which comprises many retailers, well above the 3.3% growth expected from the S&P 500. And now, analysts are rapidly slashing their projections for the sector’s growth this year. Earnings in the Consumer Discretionary sector is expected to grow by just 10.8% for the current quarter, down from the nearly 16% expected at the start of the year.

Of course, the biggest name in the group is Wal-Mart, and the results for the retail giant were less than impressive. Wal-Mart made several excuses, which included bad weather and delays in tax returns, but regardless, the company missed both the top and bottom line expectations, and issued weaker-than-expected forward guidance. The company reported earnings of $1.10 per share on revenues of $114.96 billion. The consensus was for earnings of $1.14 per share on revenues of $116 billion. Worse yet, Wal-Mart forecast Q2 earnings in a range of $1.15 to $1.25 per share, lower than the $1.28 that analysts had forecast.

Kohl’s Corp. (NYSE:KSS) also reported disappointing numbers for its most recent quarter. The company’s quarterly profit was down 9%, and sales were off 3% from the same period last year. Both earnings and revenues were lower than expected. Kohl’s also blamed the winter weather for its miss.

On the other hand, Nordstrom Inc. (NYSE:JWN) posted upbeat earnings. Earnings during Q1 were $0.72 per share, topping Wall Street’s estimates by $0.04. Revenues were up 6.5% during the quarter, and same-store sales were up 3.9% from the same period last year.

Clearly, these companies are sending out mixed signals. If the cold weather really was to blame for weakness at Wal-Mart and Kohl’s, the same would be applicable to Nordstrom as well. The saving grace has been sales from online stores and standalone stores. Even with the economy continuing its gradual recovery, consumers are still very cautious, and could continue to weigh on some retailers in the months ahead. Consumer confidence  unexpectedly dipped in May, with the Thomson Reuters/University of Michigan preliminary index indicating consumer confidence pulled back from it nine-month high to 81.8 in May, down from 84.1 in April. Analysts had forecast that the index would rise to 84.5.

If there was a bright spot, it was Home Depot (NYSE:HD). Shares of the home improvement retailer rose $1.46, or nearly 2%, to $77.96. The company’s quarterly results fell short of Wall Street’s expectations, but the company said May sales were “robust” and raised its full-year earnings forecast.

Sears’ Woes: No End in Sight to Retail Trouble

Sears and Kmart, which are both owned by Sears Holdings, are probably the best example of retailers that have failed to adapt to changing consumer tastes over the past decade. They have lost their value for consumers, and thus have little cash to invest in updating stores or expanding their footprint.

Source: Bloomberg
Source: Bloomberg

Sears Holdings issued its latest quarterly numbers, and they were not pretty. Same-store sales, the measure of a retailer’s health, were up just 0.2% at Sears and down 2.2% for Kmart. Sears’ numbers would have been even worse if it were not in the process of closing 80 underperforming stores and selling off assets. There is almost no hope of a turnaround for Sears, and the value the company has is almost entirely in its retail assets.

Sears and Kmart are all stuck in something of a no-man’s land in retail, not quite specialty enough to attract product-specific consumers and not quite the one-stop shop that big-box retailers offer. The long-term result is falling sales and earnings; shareholders just have to hope they can squeeze out enough money to earn some sort of return at the end of the day.

Luxury is the Saving Grace

Retail investors are sending a message: They see greater opportunity with the stores that cater to the well-heeled. The separation between the high-end retailers and the ones that serve the mainstream was crystal clear on Wednesday, May 21, 2014. Shares of Tiffany & Co. (NYSE:TIF) were up $7.29, or 8.3%, to $95.52 after the seller of pricey jewellery reported 50% higher quarterly net income of $125.6 million. The company topped earnings expectations by a whopping 24%.

Investors have been showing a strong preference toward the shares of luxury retailers for months. The chart below shows the performance of the four high-end retailers, up 12.5% this year, including Tiffany, Michael Kors Holdings Ltd. (NYSE:KORS), Nordstrom, and Kate Spade & Co (NYSE:KATE).

Source: Bloomberg
Source: Bloomberg

Shares of the luxury stocks are blowing away the mainstream and discount retailers. An equal-weighted index of four discounters, including Wal-Mart, Target Corp. (NYSE:TGT), The TJX Companies Inc. (NYSE:TJX), and Kohl’s is down 6% over the past year. The spread between the discounters and luxury retailers shows how Wall Street sees stronger revenue and earnings power at the companies that serve the well-heeled. And it’s not just Tiffany’s success to justify this. Wal-Mart’s shares have been struggling as the company’s revenue growth stalls.

Source: Bloomberg
Source: Bloomberg

The performance of the luxury vs. other retail stocks this year makes the differential even more clearer. All of the eight mainstream and discount retailers stocks are down this year by an average of 10%. Contrast that with the high-end retailers. All but two of the stocks, Ralph Lauren and Coach, are up. And as a group, the luxury shares are down 0.9%.

Economy Woes

May has not been kind to retailers. Adding to weak earnings results are multiple economic releases. Same-store sales are down 1.3% for the mid-May period, according to the ICSC-Goldman Sachs index. Despite stocks trading much higher than a year ago, retail sales are up just 2.4%. Economists were expecting more than 3% growth for the month, which is still a possible target.

Changing the Way we Shop

Retailers are blaming the severe winter and the economy for the challenges, but there is a deeper malaise at work: A long-term change in shopper habits has reduced store traffic—perhaps permanently—and shifted pricing power away from malls and big-box retailers.

Consumers’ rush to e-commerce is a challenge that brick-and-mortar retailers have wrestled with for years. Across a number of retailers, their defensive strategies do not seem to be panning out. Best Buy, for example, overhauled its store layouts and marketing in the past year, even inviting shoppers to “showroom” the electronics retailer—co-opting the term for people who try out products in stores and then buy them for less online.

Traffic to US retailers was hurt during the financial crisis and recession, when job losses soared and shoppers kept a tight grip on their dollars. But nearly five years into the recovery, it appears many of those shoppers may never be coming back.

Retailers got only about half the holiday traffic in 2013 as they did just three years earlier, according to ShopperTrak, which uses a network of 60,000 shopper-counting devices to track visits at malls and large retailers across the country. The data firm tracked declines of 28.2% in 2011, 16.3% in 2012 and 14.6% in 2013.

Online sales increased by more than double the rate of brick-and-mortar sales this holiday season. Shoppers do not seem to be using physical stores to browse as much either. Instead, they seem to be figuring out what they want online, and then making targeted trips to pick it up from retailers that offer the best price. While shoppers visited an average five stores per mall trip in 2007, today they only visit three, ShopperTrak’s data shows.

Retailers are missing out on chances to spur impulse purchases as consumers turn to the Web to browse or research big ticket items, while online replenishment programs like Amazon.com Inc.’s (NASDAQ:AMZN) “Subscribe & Save” are reducing the need to visit stores for everyday items like diapers and toilet paper.

The writing has been on the wall for retailer s for quite some time now, if they do not change their game now, it can only get worse…

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