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SummaryMost relevantAll NewsAnalyst Reco.Other languagesPress ReleasesOfficial PublicationsSector newsMarketScreener Strategies

Deep discounts sound warning for U.S. retail profits

12/06/2013 | 10:24am EDT
Thanksgiving Day holiday shoppers enter the Target retail store in Chicago

NEW YORK (Reuters) - Consumers have feasted on discounts this holiday season, but it means thinner profit margins for retailers from Wal-Mart Stores Inc (>> Wal-Mart Stores, Inc.) to Neiman Marcus, and car makers, a red flag for investors who have ridden a sector rally all year.

NEW YORK (Reuters) - Consumers have feasted on discounts this holiday season, but it means thinner profit margins for retailers from Wal-Mart Stores Inc (>> Wal-Mart Stores, Inc.) to Neiman Marcus, and car makers, a red flag for investors who have ridden a sector rally all year.

This week, apparel retailers including Aeropostale Inc ` (>> Aeropostale Inc) and Guess Inc (>> Guess?, Inc.) lowered fourth-quarter earnings forecasts, and on Thursday, several major U.S. retailers posted disappointing sales for November.

"We don't have an economy that is growing very fast. Prices are coming down in most cases," Jim McNerney, head of the Business Roundtable and chief executive of airplane maker Boeing Co (>> The Boeing Company), said in releasing the Roundtable's survey of chief executives on Wednesday.

"Every member of the Business Roundtable, which represents about half the U.S. economy, is facing price pressure," he added.

The discounting is expected to continue as retailers seek to hold onto market share. Shares of retailers, big winners this year, are starting to look expensive and some investors are positioning themselves to profit from a decline.

"It's troubling to some extent that while there is an increase in sales as the economy recovers, there continues to be price pressure on the retailers, especially the traditional ones," said Rick Meckler, president of LibertyView Capital Management in Jersey City, New Jersey.

Most of the major retailing sectors have seen their margins on earnings before interest expenses and taxes, or EBIT, decline from last year to the most recent quarter, according to Thomson Reuters StarMine. A group of 11 multiline retailers, including Target (>> Target Corporation) and Macy's (>> Macy's, Inc.), have seen that margin fall to 5.2 percent from 6 percent, while the auto companies have dropped to 1.5 percent from 3.6 percent.

One notable divergence is in the specialty retailers, which includes a number of luxury goods companies, apparel names and home improvement companies. Their margin has risen to 9.8 percent from 9.2 percent, in part due to Home Depot (>> The Home Depot, Inc.), Signet Jewelry (>> Signet Jewelers Ltd.) and O'Reilly Automotive (>> O'Reilly Automotive Inc).


Major sellers of apparel and other goods are expected to face cost pressures throughout the final quarter. The most recent report on third-quarter gross domestic product showed a surprising increase in inventories - indicating some overly optimistic sales expectations that will have to be adjusted for through lower prices.

L Brands Inc (>> L Brands Inc), the parent of Victoria's Secret, reported on Thursday that same-store sales fell 5.5 percent, while analysts were expecting a 1.1 percent decline. It said profit margins had taken a hit because of ramped up deals but would not say by how much. The company also noted that in its Victoria Secret online business it had to mark down unsold apparel.

Joel Bines, a managing director at consulting firm AlixPartners, said the clutter at some apparel retailers suggests many stores ordered more merchandise than they can easily sell and even luxury stores, which typically avoid holiday discounting, have gotten in on the action for the first time since 2008.

"It's going to hurt everyone's margins. It's a 'beggar-thy-neighbor' battle for market share,'" he said.

On Wednesday, Express (>> Express, Inc.) shares fell as much as 24 percent in afternoon trading, making the fashion retailer the top loser on the New York Stock Exchange after it forecast a weaker-than-expected holiday quarter amid intense promotions.

Thomson Reuters data for consumer discretionary stocks shows earnings growth estimates for the fourth quarter have fallen 4.4 percentage points to 9.8 percent since October 1. The overall S&P has seen its estimates fall 3.1 percentage points to 7.8 percent, but some think the consumer sector has further to go.

"Estimates look aggressive in that sector," said Adam Parker, chief U.S. equity strategist at Morgan Stanley, which has an "underweight" rating on the discretionary sector.

The S&P consumer discretionary sector <.SPLRCD> group of stocks has gained 35.8 percent this year, which ranks it second among the 10 S&P sectors, trailing only health care shares. But over the last five days the discretionary sector has lost 1.1 percent versus a 0.6 percent decline in the overall S&P 500.


David Strasser at Janney Capital Markets said he expects stores to offer deep discounts through the rest of the holiday season as middle and lower-income shoppers are hesitant to spend freely.

Strasser said Wal-Mart went "overboard" with discounts and rival Target could not hold the line on discounts post-Thanksgiving. Peer pressure got to Best Buy Co Inc (>> Best Buy Co., Inc.) too, he added, and the electronics chain "had no choice" but to discount more than it would have liked.

Operating margins had already been dropping for Best Buy which has been matching rivals' online prices and spending on revamping its stores. They fell to negative 0.3 percent so far in 2013, compared with 2.1 percent in 2012 and 4.8 percent in 2010 and 2011.

While major automakers reported their best U.S. sales month in 6-1/2 years this week, manufacturers provided incentives averaging more than $2,500 per vehicle in November, according to TrueCar.com.

Shares of General Motors Co (>> General Motors Company) and Ford Motor Co (>> Ford Motor Company) slid more than 3 percent on Tuesday as some investors worried that the discounts signaled a return to the practices that eroded industry profits in the years before the 2007-2009 recession.


As a result, investors have begun to hedge against a potential decline in the retail sector. The number of shares being borrowed, a proxy for short-selling, has surged in the last few days in some big names like Wal-Mart and Best Buy.

Since Black Friday on November 29, the big retail day after Thanksgiving, bets that Wal-Mart shares will fall have jumped about 20 percent, said Timothy Smith, executive vice-president at SunGard's Astec Analytics.

"There has been a gradual increase since July but it's been accelerating for the last couple of days," Smith said. As of Tuesday's close, there were 24 million shares borrowed, and with couple of million added on Wednesday, it was on track to its highest since May, he added.

Best Buy, its stock up about 260 percent so far this year, was another with high short interest, seeing a 30 percent rise in the last couple of days.

(Additional reporting by Caroline Valetkevitch, Phil Wahba, Dhanya Skariachan, Ernest Scheyder, Bernie Woodall and Maria Ajit Thomas in Bangalore; Editing by Tim Dobbyn)

By Angela Moon

ę Reuters 2013
Stocks mentioned in the article
ChangeLast1st jan.
AMAZON.COM, INC. 3.31% 3409.02 Delayed Quote.1.32%
BEST BUY CO., INC. 0.87% 113.64 Delayed Quote.12.90%
BEST INC. 2.09% 1.95 Delayed Quote.-4.41%
DJ INDUSTRIAL 1.09% 35294.76 Delayed Quote.14.07%
EXPRESS, INC. -1.36% 4.36 Delayed Quote.379.12%
FORD MOTOR COMPANY 1.62% 15.7 Delayed Quote.78.61%
GENERAL MOTORS COMPANY 0.54% 58 Delayed Quote.39.29%
GUESS', INC. -2.14% 20.11 Delayed Quote.-9.15%
MACY'S, INC. 4.02% 24.04 Delayed Quote.113.69%
MORGAN STANLEY 1.12% 102.14 Delayed Quote.49.04%
NASDAQ 100 0.63% 15146.921448 Real-time Quote.16.79%
NASDAQ COMP. 0.50% 14897.33971 Real-time Quote.15.01%
O'REILLY AUTOMOTIVE, INC 0.62% 628.99 Delayed Quote.38.98%
RISE, INC. 0.00% 27 End-of-day quote.12.50%
S&P 500 0.75% 4471.37 Delayed Quote.18.16%
SEEK LIMITED 0.53% 32.45 End-of-day quote.13.74%
SIGNET JEWELERS LIMITED -0.31% 86.48 Delayed Quote.217.13%
TARGET CORPORATION 1.50% 245.71 Delayed Quote.39.19%
THE BOEING COMPANY -0.18% 217.04 Delayed Quote.1.58%
THE HOME DEPOT, INC. 1.85% 350.41 Delayed Quote.31.92%
URBAN OUTFITTERS, INC. 0.10% 30.25 Delayed Quote.18.16%
VICTORIA'S SECRET & CO. 2.12% 52.43 Delayed Quote.0.00%
WALMART INC. 0.49% 140.55 Delayed Quote.-2.50%
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