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Quarterly sales analysis: Q1 performance and industry outlook

CONSUMER PRODUCTS INSIGHTS  | 

Following a generally positive conclusion to 2014, many retailers have failed to meet expectations to begin 2015. Several factors have contributed to the slow start to the year, including weather, frugal consumer spending despite income growth and the dock strike impacting newness and disrupting the supply chain. Director of retail and consumer products advisory services, former industry analyst Jeffrey B. Edelman, evaluates Q1 results and looks forward to opportunities retailers have to create demand and drive traffic during a potentially sluggish Q2.

Q1 sales disappointing: Retailers reporting sales and earnings cited a variety of reasons for their poor performance following promotionally driven, on-plan revenue growth in Q4. This was in spite of an easing in economic headwinds and a more favorable calendar than last year because of the earlier Easter. March and April results were accordingly distorted, but the two-month period was below expectations, following a soft February.

Weather was a significant deterrent throughout many sections of the country, and the strong dollar curtailed spending by tourists in some of the major markets. Additionally, the dock strike delayed merchandise deliveries, impacting about 13 percent of Macy's expected inventory as an example. This issue was mentioned often, accounting for some lack of newness and excitement throughout the stores. Importantly, general merchandise, apparel and furnishings have trailed total retail sales for some time now. On the other hand, Home Depot generated its third consecutive quarter of strong comparable store sales increases, with a 7 percent boost reflecting consumers' renewed focus on home improvement.

Online sales bolstered results for many stores, helping move results into the plus column. This was likely the case with Macy's, although the company doesn't specifically break out the results. Nevertheless, its reported comparable store sales were down slightly (including licensed departments). TJX, in contrast, posted a comparable store gain of 3 percent for its Marmaxx division (which includes Marshalls and TJMaxx), reinforcing consumers' interest in value and the "treasure hunt," as well as management's effective execution. Its HomeGoods division was up a strong 9 percent on a comparable store basis. Specialty stores were mixed, depending who had a fashion miss this year or was up against an easier comparison to last year. Penney and Kohl's posted better results for the latter reason.

Government retail sales data echo the disappointing trends of the quarter; however, this is the smallest quarter of the year and generally more volatile when influenced by the above-mentioned factors.

Consumer spending has trailed income growth for a while now: This disparity is despite anticipated benefit from lower gas prices; even Wal-Mart posted a slim domestic comparison of 1 percent, its second consecutive monthly increase. Employment growth remains on a slow uptrend, albeit at a slower-than-historic pace. Nevertheless, consumers continue to temper spending. Perhaps consumer confidence has been dampened by geopolitical events, or demographics are having a greater effect on consumer priorities. These trends are prevailing through most merchandise categories and price points.

Promotional activity eased off after Q4 inventory clearance; however, it appears as if more stores are increasing the number of "friends and family" events. Brooks Brothers offered 25 percent off online and throughout its stores on all merchandise. Macy's and Lord & Taylor appear to have increased event activity. Nordstrom highlighted an inventory clearance event at the end of May. Accessories, including handbags and watches, were also weaker than expected; many stores noted higher markdown rates were needed to turn inventory faster.

Deflation might be a factor behind softer top-line growth, reflecting an adjustment in price points as the mix of sales has shifted. As an example, H&M and Forever 21 are driving down average prices with their offerings and apparently making life difficult for the teen retailers, such as Abercrombie and Aeropostale, assuming the fashion content is similar. Lower-priced fast fashion retailers continue their rapid expansion. The same could be said about off-price stores.

Finally, Penney and Sears are pushing hard to regain sales momentum, as is Kohl's. Kohl's actually experienced a slightly higher average ticket as it increased its offerings of branded merchandise at the expense of some of its lower-priced, poorly performing private brands.

We are not looking for much improvement in Q2: May got off to a little better start compared to April; however, few retailers categorized Mother's Day business as great. Inventories were higher-than-expected sales for most retailers; some indicated these were planned for a variety of reasons. Nevertheless, given the Q1 sales shortfall and delayed deliveries from the port strike, Q2 margins will likely remain under pressure. Kohl's and Penney will likely ratchet up their promotional programs to drive traffic as they face tougher comparisons. June will be key to the quarter, with an important five-week period, followed by the seasonally small July clearance month. TJX management noted there was an abundance of inventory available (including what it considers high-quality merchandise), which will ultimately be flushed through the pipeline.

Higher expenses could also pressure results: Most companies tightly controlled costs last year; however, many are expecting to see a reversal this year and perhaps a deferral from 2014. The buzz term offered for this year was investment spending, whether for store growth, technology and systems, brand awareness or digital advertising. The bottom line is that top-line growth is no longer offsetting these costs. The industry is experiencing a shift in its overall advertising and marketing approach away from traditional media. Importantly, this transition is difficult to plan and estimate by quarter.

Still looking for light at the end of the tunnel: Employment growth should be sustained and the driver of income growth. However, translating this into spending is dependent on consumer confidence and psychology. The unemployment rate has been edging lower, reflecting declines in those looking for jobs, but this doesn't necessarily exert a positive influence on spending. Two variables, lower gasoline prices and demographics, have been difficult to quantify, as has the consumers' continued emphasis on frugality. Additionally, spending patterns are evolving, such that many forecasting tools are not as relevant today, particularly as it relates to millennials.

Disruption along the supply chain stands out as a major concern because of retailer cancellations. Many vendors are struggling to balance production with the lower orders and current inventory. Best business practices call for continued conservative planning; however, the risk is playing it too safe. This is a time when vendors and retailers should be more focused on creating the consumer's want to buy, rather than catering to the need to buy commodity and other replenishment items. Success will be tied to newness and self-gratification. 2015 could witness a wider spread between winners and losers.

Jeffrey B. Edelman is director of retail and consumer products advisory services for RSM, and is located in the firm's New York City office. He routinely advises senior management of companies operating in the consumer and retail sectors on strategic, sourcing, financial, marketing and distribution issues. He also works closely with internal teams on matters such as new business development, transactional advisory, including due diligence and tax. Jeff can be reached at 212.372.1225, or via email at jeff.edelman@rsmus.com.

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