Fall retail industry outlook: Looking a little better
Light at the end of the tunnel
INSIGHT ARTICLE |
The following commentary is provided by Jeffrey B. Edelman, director of consumer products industry services for RSM US LLP. 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.
Lower gas prices and interest rates remain positive for consumer spending; however, spending priorities continue to evolve away from many traditional seasonal products categories. Travel, leisure activities and home have been capturing a larger share of the consumer dollar. E-commerce continued to outpace in store sales as shopping mall traffic remained on the decline. On a positive note, those negative trends appear to be diminishing as noted by many retailers in their second quarter (July) reports.
As an example, clothing and accessories sales (according to government data) decreased -0.1 percent year-over-year (YOY) in June, an improvement from April's revised decline of -0.6 percent and May's decline of -2.8 percent. It is worth noting nonstore retail sales increased +13.9 percent YOY, to 27.1 percent of total sales (for example, autos, gas stations, food and grocery) up from 25.3 percent last year.
Improved second-quarter (July) results
Investors were generally cheered by better than expected sales and profits posted by publicly traded retailers and fashion vendors. Those companies have been providing more conservative guidance over the past year or so to the point where low expectations were surpassed. Thus, while there was a mood of optimism, their outlooks were still very guarded, more so for the vendors, whereas retailers noted gradual improvement in their business. Results by store type varied more than in previous quarters. Home Depot and Wal-Mart did well, whereas Lowes and Target were laggards.
Easier comparisons will become a more important contributing factor
Mall and retailers benefited from hot weather throughout many sections of the country generating improving (less negative) sales trends. More importantly, this was the first time in many quarters that inventory growth trailed sales, setting the stage for the potential for improved profitability this quarter. Back to school has become more relevant later in the season each year, often dependent on peer fashion influence and the need for larger apparel sizes. Additionally, those purchases have tended to be more sensitive to weather.
Gross margin could boost third-quarter profits
A number of fashion brands, including Coach, Michael Kors and Ralph Lauren, have realized less is more in terms of their product offerings. We expect a number of other brands will follow their strategy of not participating in department store promotional events in an effort to enhance profitability. While those generated incremental sales, they also undermined brand profitability. Key ingredients to this strategy will be a more frequent flow of new merchandise that will create a consumers’ desire to purchase something more differentiated at full price, fulfilling the fashion component of the price and value equation, rather than more of the same on a discounted price basis.
Outerwear, in our view, potentially represents the biggest uncertainty as there was a large amount of product liquidated during the past two warm winters, with similar merchandise likely packed away for this year, suggesting newness will be more critical to generate higher margin sales.
On the other hand, there are uncontrollable costs required to remain competitive that will continue to pressure profitability. These include:
- Higher wage costs: Wage costs and related benefits have been ongoing issues. A number of companies have offset some of the expenses through more effective scheduling, but there is a limit as to how far they can go.
- Investments to drive growth: Many retailers and vendors are scrambling to update technology as fast as possible to stay even, or hopefully, ahead of competitors. Unfortunately, these investments are difficult to budget within a certain time frame as the job needs to be completed as soon as possible to maintain and grow market share.
- Open-ended marketing costs: Sellers must communicate with their targets and know their most loyal and profitable customers. Costs to stay ahead of this effort will continue to rise. In addition, free shipping is now standard in most cases, but those costs will be increasing nearly 5 percent in January.
Overall, the outlook is positive for retailers. Sales for back-to-school and fall fashion are beginning to show gradual improvement, especially as comparisons become easier. Department stores, on a comparable basis, could be flat to down only slightly following four consecutive declines, and could show slight improvement for the holiday season. Online sales are estimated to increase at a midteen rate. The season increase, estimated around 3 percent, could be the best recorded in several quarters.
Lower inventories and the likelihood of lower markdowns could offset some of the above-mentioned cost pressures; however, retailer profits might not show year-to-year improvement until the fourth quarter. The fourth quarter holiday season is likely set for vendors, although many are expected to see improved order trends in coming months.