US Retail Winners, Losers Start To Emerge Under High Inflation

Analysts Remain Positive About Industry, Expecting Consumers To Spend

Photo Courtesy of Sundry Photography.

Last week offered a startling look, which set off a plummet on Wall Street, at how the highest inflation in more than 40 years is dragging down some of the nation’s biggest retail chains.


In a series of first-quarter earnings releases, companies and major users of retail property such as Walmart and Target reported their profits were down, missing analyst projections and sending their stock prices tumbling. TJX Cos., parent of off-price chains T.J. Maxx and Marshalls, experienced flat same-store sales. Kohl’s not only saw its comparable sales dip just over 5% in the quarter compared with last year, it also lowered its revenue projections for 2022. And on Tuesday, consumer electronics giant Best Buy reported its first-quarter net income and comparable-store sales dropped.

Many economists, as well as the National Retail Federation, are projecting that U.S. retail sales will rise in the neighborhood of 6% to 8% this year despite high inflation. At the macro level, the most recent data has been relatively positive. U.S. retail spending rose nearly 1% in April compared with March, the fourth monthly increase in a row. And despite soaring gas prices, retail foot traffic, after a drop in March, bounced back and in the week of May 2 was only down about 1% compared to 2019, according to data analysis firm Placer.ai.


“I still think the outlook is positive for the macro economy for the retail sector," said Ryan Severino, JLL’s chief economist, at a panel discussion that the brokerage held Monday at the ICSC real estate conference in Las Vegas. Despite inflation, "consumers are still happy to get out there and spend money."


But the earnings reports offered proof that retailers of all kinds, even those considered the likely winners during a time of soaring inflation, have started to feel its repercussions, raising concerns that so-called consumer fatigue may be setting in. Retailers will be making some tough decisions, on whether to pass on rising costs to shoppers by hiking prices; how to best reduce excess inventory, possibly by doing markdowns; and how to make supply chains more efficient.


“Generally, I think that all retailers will feel the squeeze as they are all facing input inflation from areas like labor costs, raw materials, shipping and overheads,” Neal Saunders, managing director at GlobalData, said in an email to CoStar News. “The problem is that they are not able to fully pass these cost increases across to consumers as shoppers are very price sensitive and no one wants to destroy demand or lose market share.”

Boost for Value Sellers


Industry analysts and economists in general have been predicting that discount chains such as Dollar General and Dollar Tree, the so-called value retailer category of Walmart and Target, and off-price chains including T.J. Maxx and Burlington Stores are in the best position to weather a period of high inflation as low- and middle-income consumers start to more carefully watch their wallets.


“Value players across all categories will see some benefits as consumers trade down,” Saunders said. “So players like Aldi and the dollar stores will do well in grocery, and off-price players will see some benefits in apparel.”


Middle-market retailers, namely department store chains such as Macy’s and Kohl’s, which sell goods involving discretionary spending on items such as shoes and apparel, could end up being the most at risk and face the most exposure with high inflation, according to analysts.


Macy’s is scheduled to report its first-quarter earnings on Thursday, a retail bellwether that will be widely watched by the industry. And Kohl’s has already outlined the hit it took at the start of the year.


Walmart, the nation’s largest retailer, in the first quarter saw its comparable U.S. sales increase 3%. But overall net income dropped 25%, to $2.05 billion, disappointing Wall Street. Profits slid because Walmart struggled with a variety of issues, several of which were one-offs or have been addressed, according to company executives.


The problems included: overstaffing as workers out on COVID-19 leave came back to work faster than expected; high inventory and a higher cost for containers and storage; and fuel costs related to its U.S. supply chain running over $160 million higher than expected.


The retailer did report behavior that economists saw coming: consumers substituting less expensive goods for pricier ones. In Walmart’s case, shoppers are purchasing more private-label groceries rather than brand names. In general, analysts expect Macy’s customers may go to places such as Target, Walmart or the off-price retailers.


Target saw sales drop and expects an incremental $1 billion in fuel costs for the full year. In the first quarter, it slashed prices in categories where it had excess inventory, when it saw patrons shift spending away from higher-ticket items such as TV sets and kitchen appliances.

‘Center of the Retail Universe’


During a webinar last week, Deborah Weinswig, founder and CEO of Coresight Research, and Ethan Chernofsky, vice president of marketing at Placer.ai, acknowledged both Walmart’s and Target’s first-quarter woes. But they essentially pegged the companies as winners this year, crediting both retailers with really understanding their customers and investing heavily on research to gauge where retail trends are headed, as well as spending on their distribution networks.


“Obviously there’s a lot of negative conversation about [Walmart's and Target’s] profit margins dropping,” Chernofsky said. “But their sales were up in both cases. And I think the reason is because even when things are difficult, they have managed to be that center of the retail universe. And so while there are these short-term challenges like supply chain and inflation and rising gas prices, it just feels wherever retail is moving, Walmart and Target seem to be a pretty significant step ahead.”


Despite the recent earnings reports and the fears of inflation and a recession, retail sales will still pace up this year, according to JLL’s Severino. Those sales will be fueled by the strong labor market and Americans whose wallets grew fatter with wage increases and stimulus money, as well as their pent-up desire to travel and eat out, he said.


“The consumer’s really being powered by how strong the economy, specifically the labor market, is. ... [People] wonder why consumption has been so strong in the face of rising inflation,” Severino said at the ICSC conference. “And it’s because the economy continues to put hundreds of thousands of net new workers to work every month. And it’s done a very consistent job of doing that.”


Both Walmart and Target are publicly traded giants with a lot of financial resources. So much so that last year they hired their own cargo ships to transport merchandise in the face of supply chain disruption, said David Silverman, a senior director at Fitch Ratings, in an interview. That’s the kind of tack that’s not an option for smaller retailers.


Macy’s has been substantially changing its real estate strategy, and it remains to be seen to what extent that has affected its results. The retailer has ramped up its openings of Macy’s Backstage, which offers bargain prices. It’s experimenting with small store formats with its Market by Macy's concept, and it’s making improvements in its flagship stores, Chernofsky said.


The current retail environment has proved difficult even for strong retail players, and it is even more treacherous for a company such as Kohl’s, which recently won a proxy fight after being blasted by several dissident shareholder groups. The retailer is examining bids from potential buyers, and one of the activist groups, Macellum Advisors, has threatened to sue Kohl’s, alleging that the company didn’t warn would-be buyers about its looming dismal first-quarter performance.


Rethinking Discretionary Purchases


Best Buy’s performance offers more evidence that consumers are shifting their spending away from certain discretionary purchases following the peak of the pandemic, as well as services and activities, according to Saunders.


“Looking ahead we are apprehensive about the consumer psyche, if only because electronics are highly discretionary, big-ticket items,” Saunders wrote in a note on Best Buy on Tuesday. “This puts [Best Buy] directly in the firing line of households looking to trim expenditure." He added that households also are "prioritizing their spend differently, with many preferring to do things like vacations than buy expensive products.”


Most retail analysts expect luxury retailers to be winners, to thrive this year despite inflation or a stock market decline. Their wealthy customers are not as price conscious as middle-income shoppers, according to some analysts.


During a webinar that JLL held last week, Dana Telsey, CEO of Telsey Advisory Group, said the luxury sector has benefited because its customer base has widened to include younger shoppers. And because of the coronavirus lockdown in China and turbulence in Europe, “the new driver of luxury is North America,” according to not only Telsey but Naveen Jaggi, JLL’s president of retail advisory services for the Americas, and Saunders.


“Luxury is more immune because its core customers have more money and are so less concerned about rising prices,” Saunders said. “Margins are also very good in luxury.”


But Steven Soutendijk, executive managing director at Cushman & Wakefield, doesn’t see it that way. During an interview at the ICSC conference, he told CoStar News that inflation and the hit that the stock market’s decline has taken on 401(k) retirement accounts will have even the wealthy more carefully consider their spending.


None of the headlines about the stock market’s recent dips seemed to faze the roughly 22,000 ICSC attendees. The exhibition floor of the Las Vegas Convention Center was filled with brokers and landlords of brick-and-mortar retail space who were busy negotiating deals, not hedge fund managers living and breathing by Wall Street, Soutendijk said.


Source: 2022 CoStar News.

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