Scott Wren, a senior equity strategist at Wells Fargo Advisors, marveled in a note to clients last week at the level of back-to-school spending he had seen in one college town.
“Having spent the recent weekend in Tuscaloosa, Alabama this strategist/parent can confirm that the back-to-school economic conditions in at least this one college town are quite good and could maybe even be considered spectacular,” he wrote. “Just give yourself plenty of time before you head to the nearest big box retailer to buy a mini fridge for your son or daughter’s dorm room. The crowds were unbelievable.”
There are other potential spots of light, too: In New England, at least one Staples store was directing parents of middle-school children to buy large quantities of needed school supplies online as their own orders had long since been depleted.
As the back-to-school retailing season starts to wind down, these stories belie the norm. That’s the problem with trying to extrapolate from what you know or can witness yourself – counting the number of cars in a parking lot, say, or looking at how quickly stock is depleted. The kind of metrics that an individual can monitor don’t always convey what is most important: How much each customer is spending during their visit, the prices that the retailer can charge and the margins that it can capture as a result.
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Overall, the National Retail Federation projected last month that back-to-school spending would drop 13 percent from last year, to $72.5 billion. And even as retailers started their promotions early – even before July 4 – the results have largely been disappointing, as one big box chain after another has posted relatively weak numbers and cautious outlooks for the rest of the year.
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That all makes investing in retailing stocks a trickier proposition than it has been in several years. Many of the big comeback stories – the Gap (NYSE: GPS), Best Buy (NYSE: BBY) – are now priced into stock prices and even a blockbuster August and September aren’t likely to radically change the market’s views of their upside potential.
Some, like Target (NYSE: TGT), may have an interesting medium- to long-term story, but the timing and magnitude of those gains is uncertain and the short-term prospects unappealing. Others, like J.C. Penney (NYSE: JCP), have never managed to get off the ground at all, and the only question there is how long the company will linger on life support.
Retailers have fared well throughout the recovery, even if it has been a bumpy ride. While the S&P 500 has gained 58 percent in the last five years, a variety of retail indices have outperformed it, with the Dow Jones Apparel Index climbing 148 percent in the same time period. That’s more of a tribute to the ability of retailers to generate higher margins, however, than it is to a favorable climate for the business: Over the same five-year time span, retail sales have climbed only 20 percent, while aggregate department store sales have fallen 9.3 percent.
Moreover, shoppers remain focused on obtaining value when they shop. “With seven in 10 Americans (76.9 percent) saying that the economy is still impacting their school and college spending plans, sales and coupons are growing in popularity,” the National Retail Federation said in a seasonal update last week. The problem may be particularly acute for apparel retailers that needed to be on target in terms of fashion trends while still offering great pricing.
Indeed, part of the retail sector that should be outperforming as kids head back to class may actually be one to avoid: apparel retailers catering to the teenage crowd. A case in point is Abercrombie & Fitch (NYSE: ANF), which had been a relative outperformer as of mid-August but announced a whopping earnings “miss” last week.
Abercrombie reported per-share earnings of only 16 cents, below the 28 cents forecast by analysts tracked by Thomson Reuters. Analysts hadn’t been terribly upbeat on same-store sales, predicting they would decline by 4.1 percent, but the actual results were far worse than expected: a decline of 10 percent. The company now is looking for its fiscal third quarter earnings to be less than half what analysts had previously expected. Teenagers, they claim, just aren’t hitting the malls the way they once were.
That’s just the culmination of a trend that began last year with mall favorites like Wet Seal (NASDAQ: WTSL) and hit the headlines early this month when American Eagle Outfitters (NYSE: AEO) warned of an earnings disappointment. Navigating this group of companies has always been tricky, given how fickle their customer base tends to be and how rapidly fashion trends change. Factor in the demographic and economic trends – nearly a quarter of all teens legally able to work this summer have found themselves jobless – and the bad news shouldn’t have taken anyone by surprise.
There are other warning signs on the horizon as retailers come through what will be the second-busiest period of the year for them, behind only the holiday season in terms of generating both sales and profits.
If teens are cautious, their parents are equally wary. Even though unemployment remains relatively high, the odds that higher interest rates are on the horizon are likely to make adults cautious about simply charging purchases to their credit cards, especially to high-interest store cards. To the extent that they are spending in the retail universe, it’s on necessities, not buying extra t-shirts or a fashionable outfit at Saks or Macy’s. Americans just don’t seem to want to spend money on discretionary items right now, Charles Holley, Walmart’s CFO, told a conference call last week. There’s no reason for that trend to reverse itself, and every reason for it to continue.
Even companies like Home Depot (NYSE: HD) that are doing well and reporting healthy increases in profits – their fate tied as much to what is happening in housing and home renovation as to broader issues of consumer confidence and spending power – appear to some to have already priced in a lot of the good news. As mortgage rates are likely to climb along with interest rates, and given that the average American household income remains below where it was before the financial crisis began, a bystander might well start to wonder where the additional leverage is going to come from? Especially when Home Depot changes hands for north of 22 times trailing earnings, well above the average market valuation, while Lowe’s (NYSE: LOW) commands a price/earnings ratio of nearly 24 times earnings.
Put the retailing stocks in your cyber-shopping basket, if you like, but refrain from hitting “buy” for the time being. There’s too much uncertainty – and too much volatility – on the horizon.
