Last week, the retail sector had to digest a
Federated Department Stores
, and it now faces many uncertainties in the upcoming quarter and months ahead.
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The Conference Board's
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Bank of America Securities'
Important data -- namely, the monthly sales reports for June -- are slated to come out Thursday, followed by the
statistics from the Census Bureau on Friday. Bill A. Dreher, an analyst at
specializing in the broadline retailing sector, breaks down some of the issues facing the sector and describes what he expects from the sector in the future.
TSC: The monthly sales figures for June come out at the end of the week. What do you expect these figures to show?
Not all retailers are created equal, and there's going to be a great distinction between the discount stores and the department stores. The department stores continue to wrestle a lackluster consumer-spending environment -- people are just not spending that much on apparel right now. Department stores' merchandise mix tends to be more discretionary-type items, whereas the discount stores are benefiting from sharper price points, greater convenience and a large percentage of sales from consumables such as food and health and beauty care items. This has allowed them to generate greater, stronger customer traffic than other forms of retail without that consumable portion of sales in their mix.
The greatest problem for the retailers has been generating customer traffic -- once a customer is in the store, they tend to spend. It's just that it's difficult getting them into the stores.
As far as Thursday -- the real thing we should be looking for, unfortunately, is a modest decline in the department store comps [sales at stores open at least a year]. As we look at them, we expect them to be down 2.2% in the department store sector, while the discount stores are going to be up roughly 3.5%. The announcement by Federated last week that sales are light is really no surprise to anyone, but [what is a surprise is] that it's going to have such a significant impact on the margins as the company is capitalizing on the July period to clear spring merchandise that is hanging around. This raises our concern that other broadline retailers that focus on apparel, such as department stores, are going to have a difficult time.
We consider the Federated management team to be amongst the best in all of broadline retailing, and they have amongst the best systems in operation of all the broadline retailers. So we expect other department stores either don't have the systems or the management to recognize the difficult situation they're in like Federated acknowledged last Thursday. Or they are not into discussing their problem right now and are hoping to turn it around. So we expect it to be a potential issue for the entire department store sector.
TSC: Do you expect the rash of recent profit warnings hitting retailers to continue? And if so, are there any companies or subsectors that are immune to the warnings and are there any that might be more susceptible?
The discount stores we believe are much more immune to this type of warning because of their consumables penetration. We do expect other retailers, particularly department stores, to make similar announcements to those Federated is making. They were rather pre-emptive in making their announcement, and we are concerned that other retailers will be soon to follow suit, particularly department stores. The business model for department stores really has not changed since its founding. All other retail avenues have sort of evolved to a greater-convenience, lower-price-type format. Department stores have really not evolved.
TSC: A lot of market watchers had been predicting a recovery in the second half of the year. Is that still a likely scenario?
One of our recommended stocks,
BJ's Wholesale Club
, has been doing very well and really has not missed a beat along the way. So, by looking at their performance, there is no evidence of a slowdown going on with them. The other retailers such as
(WMT - Get Report)
have had a slowdown, and it appears to us they are making an investment at this point and time to build customer loyalty and really stand by the customer in this period of economic uncertainty.
In the back half of the year, we expect Wal-Mart to revert back toward their historical growth rate. For this month, for example, the company is modestly above plan, as far as same-store sales go. The plan is 3% to 5% growth, and we believe when their numbers are released on Thursday, they should do about 5.5% for the total company. So they continue to drive strong sales, but they're going to be consumable-type items, which might have a lower margin than some of the general merchandise sales. And the sales did come on late in the season because of the unpleasant weather, which sort of limited the seasonal items.
Markdowns may be a greater factor this quarter than in the last quarter. The company continues to do very well and continues to grow their way through this challenging retail environment. We expect Wal-Mart to finish very strong this year.
We do not expect there to be a rising tide to lift all boats. We believe the consumer has established the bottom and will slowly be building back from the current levels. But we believe the consumer has become much more aware of value and convenience, and will be very selective where they are spending their dollars. Retailers that offer that value, such as BJ's, Wal-Mart and
(KSS - Get Report)
, are going to continue to do well and should finish the year very strong -- but that is not to say all retailers will have a strong back half of the year.
TSC: Do you expect consumers to pump their tax rebates back into the market and boost the retail sector, or is there a real possibility that consumers will hold onto that money?
We think this $300 tax rebate, and this $600 for families, will be very significant for the broadline retailers, particularly the retail stores. It looks like rebates [of] ... $39 billion dollars [will] ... be coming out over the next four months, and $300 or $600 is a lot of money for our discount-store consumers. A very modest portion of that may be saved or invested, but we expect the lion's share of that to be spent. Those consumers that are maybe living on a somewhat tighter budget and frequent the discount stores are likely going to use that rebate in the discount stores. It could be
very positive for Wal-Mart
TSC: At what point during the summer do you start to look at back-to-school sales, and how much of a boost will those sales provide to the sector?
Back-to-school is becoming less of a phenomenon across-the-board of retailing. For example, when I was a kid, my mom would take us to the department store and there would be a back-to-school sale, and you would have to capitalize on those sales to get the great prices in preparation for school. Now you're not dependent on those back-to-school sales -- you can get everyday low prices and great values at these discount stores such as Wal-Mart and
(TGT - Get Report)
. There's less of a starting gun to sound off the back-to-school season.
TSC: What other issues do you think are important to the sector in the coming weeks and months?
We're getting into the show-me stage as far as these retailers' operations and these retailers' stock valuations. And there's a lot of uncertainty as to the consumer-spending environment, the macro environment and how the companies' sales and earnings are doing, and I think investors are going to be very cautious and need to be very selective in looking at these retailers.
We believe the superior retailers with greater value and greater convenience are going to continue to do very well on the operations side. On the stock side, most of our retailers have benefited from industry-driven cyclical rallies. While there may be some more interest-rate cuts ahead, we're approaching the end of this cycle. At this point those retailers that have benefited from this cyclical rally are really going to have to justify the valuations they have risen to. Those retailers that cannot justify the valuations are going to have an issue. We choose to steer clear of the turnaround stories until we see concrete evidence that the turn is underway. Instead, we continue to focus on the proven leaders -- FD with a Strong Buy rating, and KSS, BJ and WMT with a buy rating.