Consumer Sentiment Faces Moment of Truth

Earnings Thursday from Wal-Mart, Kohl's and Target should help clarify the second-half picture.
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Investors looking for guidance on the state of consumer demand in the broader economy face a potential watershed session Thursday when the three companies that dominate the U.S. discount goods space report earnings.

Reports from


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could help solve one of the enduring mysteries of the current economy: how consumer confidence has been able to spike recently while same-store sales growth has hit a wall.

Consumer confidence rose to 106.1 July, its best reading since June 2002 and up from May's reading of 93.1, the Conference Board said. And consumer sentiment was 96.7 in July, up from May's reading of 90.8, according to the University of Michigan. Aside from a spike over 100 in January, consumer sentiment hasn't reached July's level since mid-2002.

Meanwhile, after a strong May, same-store sales growth in both June and July were the weakest of 2004, according to the International Council of Shopping Centers. Retail sales in May were up 1.4%, according to the government, while retail sales in June dropped 1.1%. July's are expected to show a 1.1% increase when released on Thursday.

The pot was stirred some more when the government's advance reading of second-quarter gross domestic product showed consumer spending up just 1%, its weakest pace since the first quarter of 2001.

People are saying one thing, doing another. Kurt Barnard, president of Retail Forecasting, says, "What is lacking is a sense of robust well-being. People feel OK, but they don't even trust their own optimism."

Still, Wal-Mart, Target and Kohl's are each expected to report second-quarter earnings-per-share growth of at least 17%. What will matter more, as ever, is guidance -- and each company will have something different to address.

At Wal-Mart, the gold-standard barometer of U.S. consumer spending, investors will be expecting an update on how badly gasoline prices have hurt its generally poorer consumers -- something the company usually offers in a prerecorded call. Wal-Mart is expected to earn 61 cents a share in the second quarter, which would compare with 52 cents a share in the second quarter last year.

At Target, investors and analysts want an assessment of the back-to-school season, as well as what the company will do with the roughly $4.9 billion in cash proceeds from the sale of its Mervyn's and Marshall Field's chains. Target will receive $1.65 billion from the sale of its Mervyn's unit to an investor group when the transaction closes at the end of the month. And the company closed on its $3.2 billion sale of Marshall Field's to

May Department Stores


on July 31.

The consensus is for a profit of 47 cents a share at Target in the second quarter, compared with 39 cents a share last year. Mark Mandel, an analyst at Fulcrum Global Partners, said income will probably come in as expected because the company -- whose customer base is more immune to higher gas prices than Wal-Mart's -- reiterated its expectation of 46 to 47 cents a share in its June same-store sales press release.

In June, the company announced a plan to buy back up to $3 billion of stock over the next three years. Depending on market conditions, Mandel said, Target may decide to reduce debt rather than buy back shares in the near term.

Other than that, Mandel thinks Target will be upbeat when talking about the upcoming months, especially the back-to-school season. While the second quarter is generally a clearance quarter, the back-to-school third-quarter is "viewed by some as a leading indicator of how the holiday quarter might be," Mandel said.

Kohl's situation is slightly different from Wal-Mart's and Target's because the company is in the process of a turnaround. Investors will be curious to see how well the turnaround is taking shape as back-to-school season gets closer, and considering the amount of new brands and products the company has announced in the last six months.

"Kohl's, as every retailer does, went through a soft patch," said Ulysses Yannas, an analyst at Buckman, Buckman & Reid. "The hot

retailers become cold, and then the cold ones turn around and become strong."

Wall Street expects Kohl's to post second-quarter earnings of 44 cents a share. The company itself predicted earnings of 44 cents to 45 cents a share in its July same-store sales press release. That would be up from 33 cents a share last year.

Yannas expects to hear that inventory management -- previously a big problem at the company -- is getting under control.

Another issue, however, is getting same-store sales back into positive territory, said Emme Kozloff, an analyst at Sanford Bernstein. Helping the matter is that the company has very easy comparisons with last year going into the back half of this year, noted Yannas.

"August will be dependent on back-to-school sales; September will see new brand introductions and rollouts that we expect will drive both traffic and average transaction sizes through the balance of the year," said Kozloff in an Aug. 5 research note.(None of the analysts mentioned hold shares of the retailers in this story, and their companies do not do investment banking for them.)