Retailers Lack Luster

Sluggish sales growth and doubts about consumer spending signal trouble ahead.
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Despite a big sales disappointment from

Wal-Mart

(WMT) - Get Report

, the rest of the retail sector held its own over the holidays. December comps came in Thursday largely in line with tempered expectations, but the continued sluggish pace of the industry raises worries about 2006.

Overall, the International Council of Shopping Centers said its holiday same-store sales index, measuring sales at stores open at least a year, rose 3.5%, hitting the upper end of its expected range for the November and December period. But analysts described the results as "moderate," "ho-hum" and "unspectacular."

Consumers were selective and bargain-focused, forcing most retailers to crank down prices in an attempt to grab market share from competitors.

At the world's largest retailer, slower sales came amid a heavy promotional push and other costs that cut into profits.

"Profit margins are going to be under pressure at a lot of companies, but at Wal-Mart, their costs are going to hurt their profit growth again," says Howard Davidowitz, chairman of retail consulting and investment banking firm Davidowitz & Associates. "They're dealing with high energy costs -- they've got a huge truck fleet, the cost of all these lawsuits, increased health care costs, higher public relations costs and additional advertising. All these things cost a lot of money."

Citing its disappointing sales results in December, Wal-Mart said its fourth-quarter earnings will be near the low end of its previous forecast of 82 cents to 86 cents a share. For its third quarter, the last one on the books, the world's largest retailer reported its slowest quarterly profit growth in years due to increased selling costs. Last weekend, it reported its December comps rose 2.2% from a year earlier, at the low end of its guidance.

Other retailers, including

Target

(TGT) - Get Report

,

Abercrombie & Fitch

(ANF) - Get Report

and

Nordstrom

(JWN) - Get Report

fared better, meeting or beating Wall Street's expectations with December sales results. But even with such bright spots, investors were unimpressed by the overall picture. The S&P retail index sank 0.3% on Thursday despite gains in the broader market indices. Since the start of December, the index has shed 0.7%.

Some of the concerns stem from reports that consumers are about to be hit by a wave of high home-heating costs after oil prices soared 17% in 2005, finishing the year above $60 a barrel. Meanwhile, rising interest rates and a slowing housing market are still giving rise to persistent warnings that a spending slowdown looms.

"Consumers are an economic accident waiting to happen," Davidowitz says. "They've been spending more than they've been earnings for years and the savings rate is now negative. They financed all this by using their home as a piggy-bank -- refinancing and extracting equity. Because of rising interest rates, consumers can no longer do that, and because we have flattening home prices, it's possible that we're headed right into a recession."

In the housing market, the National Association of Realtors said Thursday its index for pending sales of existing homes fell 2.5% in November to 120.6 from October's 123.7. That marked the third monthly decrease in a row after the index set a record in August.

Last week, the association reported sales of existing homes fell 1.7% in November to their lowest seasonally adjusted rate since March, and the inventory of homes on the market hit a 19-year high. The data have added fuel to Wall Street's speculation that the housing boom that powered the U.S. economy in recent years has come to an end.

Meanwhile, the sluggish pace of retailing has economists wondering whether more organic growth in the economy can pick up the slack. If consumers can no longer use home equity, and their interest costs are on the rise, then the only remedy for their shopping habits is wage growth. But while the economy has begun to add jobs at a decent clip, wage growth has continued to lag. Meanwhile, anecdotal examples of job cuts are popping up in a variety of different industries.

For retail investors, consumer spending is not the only place their portfolios could be affected by a slowdown in real estate. Private equity and hedge fund investors have taken a shine to the sector in many places out of a belief in the hidden value of property assets. Real estate speculation has driven up valuations on

Sears Holdings

(SHLD)

,

Circuit City

(CC) - Get Report

,

Federated Department Stores

(FD)

,

McDonald's

(MCD) - Get Report

and others.

On Wednesday, two Wall Street analysts said deceleration in the housing market could take its toll on the nation's two largest home improvement retailers,

Home Depot

(HD) - Get Report

and

Lowe's

(LOW) - Get Report

. Both chains have been longtime stalwarts of the industry, posting consistently strong earnings as consumers have flocked to their stores in order to spruce up their homes.

Sanford Bernstein analyst Colin McGranahan cautioned investors on both stocks.

"Decelerating housing trends and vendor price increases likely will dampen fiscal 2006 results," McGranahan said in a research report. "Rising mortgage rates, declining mortgage applications, lower builder optimism, increasing housing inventory, and slowing housing turnover all suggests a maturing housing market."

JP Morgan analyst Stephen Chick downgraded Lowe's to a neutral rating from overweight, citing "macro housing activity and forward earnings expectations."