Retail Looks Shopworn

Troubling signals are still emanating from the volatile department store sector.
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With first-quarter earnings from most retailers on the books, investors have turned skittish. Earnings growth has slowed, consumer spending is shaky, and a variety of chains expressed reservations about the future.

As usual, prognosticators are working with a variety of conflicting data in evaluating the sector's prospects. But the S&P Retail Index has dropped steadily so far this year, down 9%, representing a continuous lowering of expectations on Wall Street. Meanwhile, Thomson First Call estimated that earnings growth for retailers has slowed to around 8% in the first quarter, down from 20% for the fourth quarter of 2004 and down 62% in the year-ago period.

Most analysts agree that consumers hit a soft patch during the quarter that was mostly attributable to high gas prices and bad weather. The situation bears a striking resemblance to the slowdown that hampered the stock market last summer. Back then, some observers proclaimed that consumers finally had reached the end of their spending rope, only to be proven wrong when a healthy holiday followed the president's re-election.

A year later, the situation could be more dire.

"We expected some weakness here, but the depth of some of the reductions in forward guidance for the June and September quarters are a little surprising," said Andy Graves, a retail analyst with Pacific Growth Equities.

The quarter's biggest disappointment came from the world's largest retailer,

Wal-Mart

(WMT) - Get Report

. The mass-merchandising behemoth reported weaker-than-expected profit on weak spring sales and warned that results for the current quarter would miss Wall Street forecasts.

Wal-Mart's chief rival,

Target

(TGT) - Get Report

, fared better, beating earnings estimates by a penny a share and affirming second-quarter guidance. The contrast among discounters suggested that Wal-Mart's problems were specific to Wal-Mart, but a close look at their monthly sales results reveals they both suffered slowdowns in April.

Target's same-store sales growth dropped to 1.3% for the month, down from 8.2% in March and 9% in February. The drop-off marks a significant departure from the company's historical average. Meanwhile, Wal-Mart posted a same-store sales gain for its U.S. operations of only 0.9% in April, after the previous two months showed uptrends of 4.1% and 4.3%, respectively.

Despite the disappointments from the two heavyweights, the government said retail sales rose 1.4% in April, exceeding estimates from economists on Wall Street. Also in the plus column, the International Council of Shopping Centers said its tally of monthly sales reports from retail chains exceeded its expectations, with the overall index showing a 2.2% gain. Still, that marked a slowdown from March, when same-store sales rose 4.3%, according to the council.

Elsewhere, Lowe's missed Wall Street's estimates by 2 cents, albeit with a 31% jump in profits. Investors bid up the stock, reflecting faith in the home-improvement market that is expected to benefit from demographic shifts and increased immigration levels. That faith appeared justified when

Home Depot

(HD) - Get Report

said it beat estimates and reaffirmed its full-year guidance.

Even with its success, thanks largely to cost management and product mix, Home Depot acknowledged that retailing has gotten harder.

"While fuel prices may have affected the number of store trips from customers, we have not seen an impact of fuel prices on average ticket sales," said Home Depot's president and chief executive, Bob Nardelli. "We view this as evidence of our ability to execute in a difficult retail environment."

Two department store retailers joined Home Depot as standouts for the sector.

J.C. Penney

(JCP) - Get Report

, still in the groove after its successful turnaround efforts, said its quarterly earnings quadrupled from a year ago, and it offered second-quarter guidance in line with Wall Street's estimates.

Also,

Federated

(FD)

beat earnings estimates by 4 cents, boosted by strong demand for spring fashions. However,

May Department Stores

(MAY)

, which Federated recently agreed to acquire, said its earnings fell 37% from a year ago, hurt by weak sales of its proprietary ladies' and men's apparel brands and incremental markdowns.

Even with good news coming from a handful of major retailers, Graves pointed to slowdowns coming from apparel companies such as

Gap

(GPS) - Get Report

,

Saks

(SKS)

,

Limited

(LTD)

,

Fossil

(FOSL) - Get Report

,

Jones Apparel

(JNY)

,

New York

(NWY)

and

Liz Claiborne

(LIZ)

as cause for concern.

"People talk about rising rates and rising oil prices, but I think there's something bigger than that going on," Graves said, pointing to rising state and local tax rates, parking costs and food prices. "The effects of the rising cost of living relative to the growth in wages, which has been stagnant, is starting to pinch a broader demographic."

He said the effects are less pronounced among teen apparel retailers. Those chains have long been the retail sector's stars, but signs of weakness are beginning to show up there as well. Monthly comps, which have been consistently in the double digits at chains such as

American Eagle

(AEOS)

and

Abercrombie & Fitch

(ANF) - Get Report

, have mostly dropped into the mid-single digits. The decline is partly due to tough comparisons to last year, but some former standouts have been struggling, such as

Pacific Sunwear

(PSUN)

and

Aeropostale

(ARO)

.

Investors even bailed on American Eagle last Thursday after it said its first-quarter profit more than doubled on spring sales of its teen clothing, and said second-quarter earnings would beat analysts' average forecast. The stock traded down 6% on the session, after management expressed concerns about upcoming comparisons and analysts predicted a slowdown was in store.

"It's becoming a more competitive environment and you can succeed if you execute and differentiate yourself, but it's not the layup that it was a year ago," Graves said. "Last year, we came out and said 'buy everything.' This year you have to be far more selective."