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Comparisons: The Year Ahead

The pressure is building on retail stocks and Wall Street is beginning to turn its attention back to the sales line.

The pressure is building on retail stocks and Wall Street is beginning to turn its attention back to the sales line.

Most chains got a pass last year as investors contented themselves with leaner and meaner businesses that could turn in better profit margins. But that might no longer be enough. Expenses have been cut to the bone, making earnings growth more dependent on better sales.

And comparisons will only get tougher as 2010 progresses and retailers lap last year’s downturn. So even if business is relatively stable month-to-month and quarter-to-quarter, sales and earnings will be seen as shrinking and that perception is expected to have much more of a bite this year.

“Broadly speaking, with retailers as well as with the vendors…I would say that for the first half of the year, comparisons are still pretty easy,” said Christine Chen, Needham & Co. retail analyst. “The market bottomed in March and it wasn’t until the second quarter that consumers didn’t feel the need to slit their wrists.”

To succeed, Chen said stores and their suppliers need to focus on differentiated merchandise to attract consumers. “It’s always about product but, in this environment, it’s even more about product,” she said. “I don’t think the consumer is out of the woods, but they are starting to tiptoe back.”

Chen said stocks would reflect the growth potential of the company, as opposed to last year, when “the best performers” relied on “cutting costs, not top-line growth.” Among the analyst’s potential top-line darlings are Urban Outfitters Inc. and Guess Inc., both of which offer unique fashions and can expand both domestically and abroad.

The early signs for stocks this year haven’t been encouraging. The S&P Retail Index began the year at 411.12 but by Tuesday’s close had descended 3.2 percent. In the same time period, the Dow Jones Industrial Average fell 2.2 percent.

In many cases, it is international expansion that is most attractive for retailers right now, despite the perennial problems associated with opening up in a new market with new customers and laws and so on.

The global economy is expected to grow 2.9 percent this year, according to IHS Global Insight, but it is the quickly growing Asian economies that have most of the momentum.

“So far, this is shaping up to be a two-speed global recovery, with high-debt countries and those hardest hit by the financial crisis — including North America and much of Western and emerging Europe — in the slow lane, and with most emerging regions — especially Asia — in the fast lane,” said IHS economists Nariman Behravesh and Sara Johnson in a forecast.

The economies of advanced countries are expected to grow 1.8 percent this year, as emerging markets expand 5.5 percent.

All eyes are on China, which grew its GDP by 8.7 percent last year and is expected to expand even faster this year. Worries that the Chinese banks would curtail lending as part of an effort to keep the economy from overheating spooked investors last week and sparked a global sell-off. But fashion companies that have been moving to China to tap into its 1.3 billion consumers appear to be there for the long haul.

“Coach [Inc.] and Polo Ralph Lauren [Corp.], these companies have really strong potential in China regardless of whether China’s GDP grows 4 or 8 percent this year,” said Marie Driscoll, an equity analyst at Standard & Poor’s. “This is a long-term opportunity for them.”

Companies that are unwilling or unable to expand outside the U.S. might face somewhat dimmer prospects, at least in the short term.

“Unemployment is getting worse,” Driscoll said. “A lot of the levers of consumer spending — disposable income, employment trends — they’re not positive. When do they turn positive? When do they stop going negative?” On the plus side, she said travel is expected to be down and that some of those dollars could flow to retailers.

The U.S. economy has shed 7.2 million jobs over the last two years, with unemployment rising during 23 of the last 24 months. Unemployment stands at 10 percent, down from the 10.1 percent seen in November, but higher than any other time since 1983.

“At 10 percent, it really puts a crimp in spending and retailers are the first ones to feel that,” said Andrew Fitzpatrick, director of investments at Hinsdale Associates. “It’s a slower growth environment. Consumers are deleveraging. The spending will pick up, but it’s going to be slowly. Americans have learned some lessons about living above their means.”

Even with a dour macroeconomic outlook, this year is still shaping up to be much better off than last year or late 2008.

“Monthly results could be lumpy, but overall, each quarter this year should be significantly less negative and even positive for most retailers,” said Holly Guthrie, analyst at Boenning & Scattergood. “Retailers who saw positive [comparable-store sales] were able to produce those comps mostly on improved conversion and or better average unit retail price.”

Guthrie said this will be the trend for the “foreseeable future in 2010,” and “therefore any seasonal factors,” such as timing of holidays, spring breaks and shifting of weekend days between months, might cause some months to be “weaker than others as events and promotions are shifted.” Erin Armendinger, managing director of the Jay H. Baker Retailing Initiative at University of Pennsylvania’s Wharton School of Business, said smart companies will be returning to the “fundamentals of retail” this year.

“At the end of the day, you’ve got to be a retailer,” she said. That means having superior product and a great customer experience.

Armendinger said the industry is facing a period of evolution, rather than revolution. “I honestly don’t think there’s a fundamental shift in retail,” she said. “There have always been store closures and new concepts. It’s all very cyclical. I’m not sure we should worry about when we anniversary the cuts. It’s more about fundamental business practices. People have to have a reason to buy.”

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