Rate, Margin Worries Set Backdrop for Retail Firms' Earnings

The next two months typically play out well in the sector, but investors have been finicky recently.
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February and March are usually good months for retail stocks. The uncertainty that surrounds the all-important Christmas sales season is over, and the next holiday season is too far away to worry about.

This year, however, may be different, thanks to a number of factors that are none too favorable for retailers: rising interest rates, tough same-store sales comparisons and possibly peaking margins. With that kind of emotional baggage, retail stocks don't look to be zipping back anytime soon.

First up: this week's

Fed

meeting. Most economists figure that Alan & Co. will raise rates by 25 basis points this time and another 25 basis points next month. Yeah, yeah, this isn't a new story. Rate fears have plagued retailers since last spring. But as long as there's the chance of further hikes, worries aren't likely to go away anytime soon. "The Fed is the broad macro question," says Jeffrey Feiner, analyst with

Lehman Brothers

.

The Rating Game

Of course, it'll take a lot to slow down the American consumer, who's now been shopping for 107 months straight in the longest U.S. economic expansion ever. But rate worries aren't to be dismissed when it comes to retail stocks. Last month, retailers like

AnnTaylor

(ANN)

,

Williams-Sonoma

(WSM) - Get Report

and

Tiffany

(TIF) - Get Report

got

hammered despite good sales. Williams-Sonoma and AnnTaylor shares have fallen 26% since December sales were announced, while Tiffany shares have slipped nearly 10%.

To make things worse, same-store sales may not be as robust as in the past. Most retailers report sales for January -- which make up just about 20% of the quarter -- on Thursday. Despite winter storms in the third week of January, 100 retailers tracked by

Deutsche Banc Alex. Brown

will likely post a 5% increase in monthly sales, just slightly ahead of plan, the bank says. But compare that with last year's 8% jump for the month, which was more than double plan.

And comparisons remain tough through the first half. Slower same-store sales, in turn, make it harder for retailers to post improvements in gross margins, or the profit a company gets from a sale. Retailers may also increase markdowns, and may be nearing the end of cost savings they've squeezed out of cheaper raw materials from Asian nations. Both of those may also lead to slower margin improvement. "Fabulous" margin improvements helped specialty retailers last year, says analyst Maura Hunter Byrne with

Salomon Smith Barney

. But looking ahead, "are there any more margin opportunities, or was 1999 too good to be true?" she asks.

Retailers are likely to give clues when they report fourth-quarter earnings in February and March, and analysts say they'll be listening.

Margin? No, Parkay

"For specialty retailers, it's something we're very focused on," says Angela Auchey, an analyst with

Federated Investors

, whose retail holdings as of Sept. 30 included

Wal-Mart

(WMT) - Get Report

and

Toys R Us

(TOY)

. She says in the past some retailers with strong brands, like

Abercrombie & Fitch

(ANF) - Get Report

, have been able to lift prices on popular goods. No longer. And in a deflationary environment, "if they can't get pricing, it's hard to grow," says Auchey. (Federated sold some of its Abercrombie shares during the quarter that ended June 30 but retains a stake in the company, according to

Bigdough.com

.)

To be sure, retail stocks have already been hit hard recently because of all of these concerns. The

S&P Retail Index

(which includes general merchandise, drug and food retailers as well as specialty retailers) has fallen more than 15% so far this year. But an unpleasant surprise can still throw a scare into investors. There's already a cautionary poster child: Earlier this month,

Bebe

(BEBE)

reported a 30% increase in fiscal second-quarter earnings but said that gross margins had declined and would likely do so for the near future. Its shares have since fallen 26%.

In short, investors have shown that they can get awfully jittery when it comes to rates, slower sales and margins. And that nervousness is worth bearing in mind, even during the usually cheery months for retailers.