Retail Earnings May Bring Summer of Discontent - TheStreet

Retail Earnings May Bring Summer of Discontent

There hasn't been a wave of downgrades, but retail analysts and investors are on the lookout.
Publish date:

Are the wheels about to come off the retail earnings machine?

Retailers have now had two months of soft sales, and so far June isn't looking good, either. Blame the slowdown on the tough comparisons with last year, blame it on a consumer spending slowdown or blame it on the rain: earnings for the quarter ending in July may disappoint.

But don't count on analysts to give you a heads-up on this. There have been relatively few downgrades coming from analysts, so far, although the quarter's body count may grow. However, given the way the market treats surprise earnings disappointments these days, a soft July quarter means things could be rough for the retail group later this summer.

Some companies have come right out and said that things aren't looking too hot. In late May,


(COST) - Get Report

said it would miss earnings estimates for its fiscal fourth quarter, which ends Sept. 3. More recently,

Urban Outfitters

(URBN) - Get Report

said Thursday that lower-than-expected sales will reduce second-quarter earnings. And gadget seller




Monday it expects a loss in the second quarter, not the gain predicted by analysts, due to weak Father's Day sales (weak demand for motorized tie racks, apparently). Since its announcement, Costco's stock has fallen 21%; the others have lost about 10%.

And analysts have recently taken their knives to several more, last week shaving estimates on some department and general merchandise stores, including


(DDS) - Get Report





JC Penney

(JCP) - Get Report









(S) - Get Report


But given the slowdown in sales, there haven't been


many reductions in consensus earnings estimates, says Joe Kalinowski, chief equity strategist with

I/B/E/S International

, which tracks analysts' estimates. "I don't see a massive downgrade, even though overall, everyone would expect more negativity," he says.

The culprits behind the projected shortfalls: The usual suspects. Retailers posted big sales gains last year, which makes it that much harder to improve on sales this year. The weather has been loopy all spring -- chilly when it's supposed to be warm, disgustingly hot when it's supposed to be balmy. That's done nothing to help sales of summery stuff like shorts and barbecues. And finally, it appears that hyperactive consumer demand is finally taking its Ritalin; things appear to be slowing down.

But this little bit of cognitive dissonance -- lots of low sales, few lower estimates -- may mean some gnarly surprises come earnings season. One hedge fund manager who wants to remain anonymous says he's increased his short positions in retailers because of the increased earnings risk. Todd Slater, retail analyst with

Lazard Freres

, says there are "multiple candidates at risk from here on out."

Getting people to actually name which companies are at risk is a little tougher. Department stores, most vulnerable to economic slowdown, have so far been the main victims of downgrade fever. Some analysts are

warning that


(TGT) - Get Report

, because of its string of sluggish sales, might miss estimates.

Slater says specialty stores, particularly those targeting teens, are at risk. In addition to all the other factors, there are simply too many teeny bopper retailers adding too many new stores -- enough even to exhaust the spending potential of indefatigable Generation Y. (Urban Outfitters fits into this niche.) "I expect more preannouncements and earnings misses, and then a rationalization of supply growth needs to occur," he says.

While it's not a niche player, Slater thinks


(GPS) - Get Report

also has the potential to fall short of

First Call/Thomson Financial's

consensus estimate of 26 cents a share. Slater rates Gap shares a long-term buy and his firm hasn't done recent underwriting for the company.

He's not alone. Kindra Hix of

Banc of America Securities

recently cut her rating on Gap from strong buy to buy. With demand slowing and markdowns increasing, the company will need to see a pickup in sales and earnings before the end of the quarter in order to make her estimate of 27 cents a share, she said in a research note. (Her firm hasn't done underwriting for Gap.)

The key to her caution was the rise in markdowns. It's one thing if a retailer sees a slowdown in sales, but if it's selling goods at full price, it can still make money. The trouble comes when sales slow and the company gets stuck with a bunch of seasonal goods. Then it's got to slash prices to get the stuff out of the store, which hurts margins.

Of course, the second quarter still has another month or so to run. And if the mall rats get a sufficient jolt from their summer slumber, all this concern could be for naught. At this point, though, it would take a nice little spree to boost sales enough to make up for the saggy May and June.

That kind of reversal is what retailers are hoping for. Investors in retail stocks should hope that they're right.