Quarterly sales analysis: Q4 2015 performance and industry outlook
CONSUMER PRODUCTS INSIGHTS |
Retailer struggles generally continued in Q4, as warmer than expected weather and increased promotion and inventory levels negatively impacted profitability. Unfortunately, looking forward, retailers will likely face sustained growth pressures as consumer spending continues to shift, and comparisons remain difficult. RSM US LLP director, consumer products industry, former industry analyst Jeffrey B. Edelman, discusses the widespread Q4 challenges, whether profitability has peaked for some retailers and why companies of all sizes must rethink their business model to stay competitive.
It was a terrible quarter, as the year ended on a down note: Contributing factors have been widely publicized:
- Higher than normal retailer inventories relative to expected sales coming into the quarter
- Sales below plan for most retailers, due to unseasonably warm temperatures, including record highs in some sections of the country, which negatively impacted cold weather merchandise
- Intense promotional activity throughout the holiday season
- Industry inventory levels, despite significant and costly clearance, ended the quarter above Q1 sales expectations
There were few exceptions—those that were compared against depressed results the previous year such as JC Penney.
Enough about the past; what about the new year? Apparel deflation, as experienced in the past several quarters, will likely pressure sales growth over the next several quarters reflecting mix, channel shift and promotion. Consumer spending will likely maintain its shift to other categories. General merchandise sales growth will likely maintain a below-normal pace through the first quarter adjusting for the Easter calendar shift.
Most retailers have signaled continued pressure on profitability at least through the first half, after which comparisons become easier. Many branded and private-label suppliers have expressed similar concerns as retailer buying plans have been pared back.
Channel and mix shift will likely be ongoing: The higher-end product categories were hit harder than in previous quarters, as promotional activity spread across most sectors. These included added friends and family and charity events that carried through to the luxury brands that posted sale signs earlier than previous seasons. As a side note, women’s accessories, including handbags, appeared to show some signs of leveling; it was one of the first sectors to experience a softening in sales.
The off-price stores generally posted better sales results as consumers gravitated to their value offerings. Interestingly, TJX was one of the few that reported higher comparable stores in the fourth quarter (+5 percent), but also enjoyed a higher gross margin, in part due to an abundance of manufacturer discounts. Its home products categories were singled out as among the strongest, consistent with industry trends.
The strongest gains were reported by the home improvement companies, a trend that has been maintained for several quarters. Traditional discount stores also fared better, reflecting a higher proportionate mix of consumable items. Average pay in low-wage industries is growing faster than average pay in high-wage industries for the first time in many years, a potentially positive sign for lower-end product lines and retailers.
Omnichannel was the top-line winner, cutting into profitability more than expected: Online sales contributed several percentage points to retailer top-line growth. The goal of expanding or maintaining market share was successful for many; however, the business model needs to be fine-tuned.
Transparent pricing has proven to be one of the most difficult to remain competitive and consistent across all channels. In addition, free shipping was an important sales driver in the recent quarter over those that had a minimum spend requirement. Ongoing technology investment remains one of the highest priorities, costs and pressures on profitability in an effort to offer the best consumer shopping experience. Logistics and timely delivery are key focal points.
Shifting composition of store growth: Most large public retailers announced reductions in store expansion and increased store closings in an effort to help restore profitability. As omnichannel likely drains several percentage points from same-store growth, lesser productive stores are experiencing a sharper fall off in profitability. Store closings, particularly when leases expire, are the correct alternative; however, there is a corresponding negative impact on corporate overhead coverage, forcing retailers to further rethink their business model. The real issue is whether profitability has peaked for the mature retailers?
Taking Macy’s as an example: it reached its past goal of a 14 percent EBITDA rate in 2014, but declined close to 12 percent in its recent fiscal year. “Investment spending and initiatives” are expected to weigh down on profitably as it reinvents its business model. To paraphrase: “margins will likely remain under pressure until the economy improves to the point where industry sales can recover to a 3-4 percent rate of gain.”
Most traditional retailers are paring lesser profitable locations as they focus more on their omnichannel efforts. On the other hand, some of that volume will likely be captured by the ongoing growth of value and fast fashion retailers. Sears and Kmart will probably continue to be market share donators, but not enough to make up the difference.
Additionally, and perhaps more importantly, there is a growing effort by vendors to accelerate their own store rollout program. These include many brands such as Under Armour and those owned by VF Corp, which can help control their destiny, generate consumer interaction and capture incremental margin.
The bottom line: Retail is a zero-sum game. Lifestyle spending is outgrowing personal consumption of many merchandise categories. Costs to grow share of what could be a stable or declining market are increasing. Retailer and brand managements need to refocus on their business model to justify continued investment.
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 firstname.lastname@example.org.