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Quarterly sales analysis: Q3 2015 performance and industry outlook

CONSUMER PRODUCTS INSIGHTS  | 

Struggles continued for retailers in Q3, as positive economic indicators during the summer generally failed to lead to increased sales. Weather and changing consumer demand both had a significant impact, as well as a potential disconnect between vendors and retailers. RSM US director, consumer products industry, former industry analyst Jeffrey B. Edelman, discusses the difficulties companies faced in Q3, as well as the positives that have emerged, and why there is reason for optimism during the holiday season.  

Hope for Q3 did not translate into sales: Three months ago, economists saw signs of a steadier economy in the July spending numbers that appeared to bode well for the last half of the year. Employment growth and wage gains should have been among the biggest contributors to sales growth, but those expectations fell short of reality.

Delayed back-to-school promotions and sales tax holidays from Q2 were expected to be a catalyst to improved sales; however, unseasonable weather and consumers’ desire to spend on other categories resulted in a shortfall for another quarter. Cold weather categories were most negatively impacted, a particular call out by Dick’s Sporting Goods.

High end-of-the-quarter inventories led to a more promotional Q3, negatively impacting retailer margins. Unfortunately, most retailers ended the quarter with even higher inventory to expected sales. Further compounding the issue was that companies previously scaled back their Q4 expectations. Traditional department stores and specialty formats posted the most disappointing results. As usual, fashion issues seemed to be the center of concern.

Vendor concerns reinforce cautious outlook: Many vendors reported their Q3 (September) results ahead of retailers’ October fiscal quarter releases, setting the stage for the earlier-mentioned disappointments. Handbags and accessories, which were a traffic driver for many stores, weakened further in the period. Lack of newness and excitement, as well as consumers’ preference for smaller sizes negatively impacted sales. The call out of excess inventory, for vendors and at the store level, was across the board from Ralph Lauren to Michael Kors.

Interesting CEO comments: Macy’s CEO Terry Lundgren sounded perplexed in answering questions on its investor call. He passed the buck to some of their vendors, noting sales would improve when more exciting merchandise began to flow into the stores. Retailers often make comments such as this, but one has to question whether if there really was a fashion problem and lack of newness, why the merchants made the commitments, except for knowing they would be bailed out by markdown allowances. There could be some interesting end of the quarter discussions as Mr. Lundgren stated the consumers would benefit as it aggressively moved to clear excess inventory.

Nordstrom reported similarly unexpected weakness. Blake Nordstrom noted they were merchants and not economists; their primary focus was to move inventory out as quickly as possible to be clean for Q4. Nevertheless, the company lowered its sales and profit expectations.

There were a few bright spots: The home sector remained one of the stronger categories during the quarter, demonstrated by the strong gains by Home Depot, Lowe’s and TJX’s HomeGoods division. The value theme resonated with the overall sales increases by TJX’s overall business, still appearing to siphon sales from traditional department stores. Interestingly, average unit prices were lower than last year due to mix. On the other hand, Nordstrom Rack posted surprisingly weaker sales than its department stores.

By comparison, retailers that had been doing poorly, such as Kohl’s, Penney, Target and Wal-Mart posted better sales because of easier comparisons.

One final note on the recent quarter, most of those companies that beat their publicly stated expectations, did so because of very conservative guidance—rather than experiencing an uptick in their business.

E-commerce drove incremental sales at the expense of profitability: Omnichannel has become the great equalizer, enabling bricks and mortar retailers to maintain or grow market share, even though comparable store sales declined and are becoming increasingly difficult to define. This is a two-edged sword; store margins are squeezed on lower sales productivity, while free shipping and returns eat further into profitability.

Q4 outlook—maybe a few tail winds: Consumer spending is projected to rise around 5 percent, one of the better increases in recent years. This figure reflects strong October employment growth, lower gas and heating prices (partially offset by higher food costs) and the highest level of spending indications since 2007, as noted in a recent Gallup Poll.

Key spending categories to show growth this year include: travel, home, services, toys and gift cards.

Upcoming challenges and opportunities: Retail sales will likely trail consumer spending for another quarter, with estimated 3 percent plus gains reflecting the previously mentioned shift in consumer priorities. In addition, deflation owing to channel mix and promotion will presumably inhibit overall sales growth.

However, the calendar is favorable again this year, with one extra day between Thanksgiving and Christmas. In addition, Christmas falls on Friday this year, in contrast to a Thursday last year, with the potential for strong weekend sales after the holiday. Although, Black Friday and Thanksgiving openings will be less important than last year.

Consumers are projected to shop earlier through a variety of channels this holiday season, with two-thirds of sales likely to be digitally influenced. Stores with strong e-commerce presence will likely be winners, with ease of transaction, delivery and returns most important to consumers.

Jeffrey B. Edelman is director of consumer products industry services for RSM US LLP, and is located in the firm's New York 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 +1 212 372 1225, or via email at jeff.edelman@rsmus.com.

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