Who Says Retailers Aren't Feeling the Impact of Higher Rates?

Briefly:

Interest rate reality: Never mind yesterday's report of consumer confidence for May, which was stronger than expected. Some folks (read: JJC) suggest that means May retail sales will also be strong. Perhaps, but high rates are clearly taking their toll on retailers. The trouble was felt quickly, quarters ago, at low-end retailers like Ames Department Stores (AMES), where trouble started showing up several quarters ago -- almost in tandem with the rate increases.

Now there are signs that as rates go even higher, the impact is starting to move into the middle market, especially with items that can be deferred. Take the case of Furniture Brands International (FBN), whose brands include Broyhill, Lane and Thomasville. Yesterday, in a release that went virtually unnoticed, the company warned of lower-than-expected second-quarter earnings and put the blame almost squarely on higher rates. "The Federal Reserve's interest rate increases appear to be starting to impact consumer demand," says CEO Mickey Holliman. He says Broyhill and Lane, which cater to the middle of the market, have been feeling the pinch over the past four to five weeks, while Thomasville has been hurt "to a lesser degree."

And while we're at it: Notice Office Depot's (ODP) earnings warning last Friday? The company blames it on slowing comp-store sales. Why the sudden cutback? Could it be that while the consumer is starting to feel the pinch of interest rates, the vaporization of so many dot-coms is starting to take its toll on the businesses, such as Office Depot, that were serving them? With little in the way of assets, these companies can be shut down as quickly as they started. Something to think about, especially in the context of old-fashioned economic slowdowns that used to take a while to evolve. This slowdown, if it really is happening, may occur on Internet time.

Peppered by Salton: If you had nothing better to do over the holiday weekend (in other words, you have no life) and you decided to scroll through the "corrections" section of TheStreet.com, you'll see a correction tied to a Hotline item from last week regarding Salton (SFP). The item in question mentioned a PaineWebber report regarding Salton, and how the analyst Jim Goll felt the company could wind up with enough free cash flow next year to pay a dividend. I then wrote: "I guess that means the company will have paid off $125 million in junk bonds -- the same junk bonds whose restrictive covenants include a ban on the payment of any dividends." Not quite right, and not proud of it! The covenants don't include an outright ban, but they do carry restrictions in regard to the payment of a dividend that could prohibit a dividend. On top of that, the company's credit agreement with its bankers, who exert more control than the bondholders, also has restrictions on the payment of dividends under certain circumstances.

And while we're on Salton, to clear up one other thing: The same item said that last year Salton had negative free cash flow of $100 million and for the first nine months of this year had positive cash flow of $6 million. Salton argues that the correct numbers are more like a positive $9.8 million and $38.4 million, respectively. That's a big difference. Different analysts and companies use different definitions of free cash flow. Salton's is the most common: Operating cash flow minus capital expenditures; the numbers I used, supplied by a source who is short Salton, also deducted cash paid for acquisitions. Some analysts believe, as Salton argues, that acquisitions are a one-time use of cash, so they should not be included unless the company is an active acquirer; others, such as my short source, believe acquisitions should be counted because acquisitions represent a legitimate use of cash.

Finally, from the "truth is stranger than fiction" department: In a note to clients last week after Federal Mogul's (FMO) latest rout, Credit Suisse First Boston analyst Ronald Tadross wrote, "Management also indicated that marketing and R&D costs have been deferred, over the past few quarters, in order to make earnings estimates." (Think about it: the company actually admitted that it tried every trick in the book to make its earnings look better than they really are, and even then couldn't make the grade. Now that's pathetic.)

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