Aug. 19, 2022

Retail's Greatest Challenge In A Half-Century

For those who have spent our career in sales, what's happening in retail, has a very familiar ring.

Imagine the following: the Sales Manager walks into the Boss's Office and proudly declares: Sales are up, Sir. So are profits. Things couldn't look better. The Boss looks at the numbers, and sure enough, sales are up, profits too. So, he decides to give the entire sales department a raise.

But later, the Boss looks around and suddenly realizes things aren't so hunky dory. The bills keep mounting, there is a lot more leftover inventory than there should be, and the company is suddenly in trouble financially.

How could this happen? Especially when the sales department just had such a boffo year?

The answer to this puzzle lies in our history. But a history that goes back nearly 50 years to the last time we had inflation of this magnitude: the 1970s. And what's happening to our fictional Boss and to many real-life retail companies is that they are caught in the maelstrom of runaway prices. A storm that they did not create but that they now have to learn to survive.

This week we have 13 major retail stores scheduled to announce earnings. Nine have already been reported, with the balance on the calendar for later today. So far, five of the companies have beat Wall Street Estimates, while four have reported lower earnings.

And most of the reports have been a variation of our story of the Sales Manager and the Boss. Almost all of these companies are reporting higher sales. That's a good thing.

Usually, I would say that yes. But not this year. Unless sales increase by more than 8 1/2%, it's pure delusion. 8 1/2% was the inflation rate over the past year. And to see improving sales, you need to have sales that exceed inflation. Otherwise, you're just spinning your wheels.

Inflation leads directly to the Boss' second problem: leftover inventory. Inflation drove up the price of all the goods in the warehouse. So sales could sell fewer items at a higher price and still meet their goals. And leave the Boss with the leftover inventory.

And in fact, this is just what is massively occurring at Walmart. Walmart reported that inventories are up 26% over last year. And they are busy canceling billions of dollars of new orders to bring stocks back to normal.

Put it all together, this first year of runaway inflation wasn't too bad for most retailers. Unfortunately, the worst may be yet to come.

Over the next few years, we'll likely hear much about "pricing power." As inflation relentlessly drives costs higher, the retailer must be able to increase their sales prices to meet those escalating costs. Pricing Power will be the key to any retailer's survival.

That's the sinister part of inflation for the retailer. It does give a nice inventory bump that first year. But after that, it is a continuing struggle to keep raising prices to meet costs.

And pricing brings me to the current American Retail Model. The most dominant retail franchisers use a discount price model. Now they each may have their unique wrinkle. But at their heart, they are all discounters.

Walmart is the nation's largest discounter, and if you listen to their ads, they all lead with low prices. Amazon is the nation's largest online discounter. Again, for Amazon, the price is the all-important driver. BJ's Wholesale is the best performing retailer this reporting season, as shoppers gravitate more and more to low prices.

The whole point of a discounter is that they operate on paper-thin margins. And this will be highly problematic if, as I believe, inflation will be with us for a while.

I remind you of the many retailers who have gone out of business over the past few decades. The list is lengthy. Thin margins give little room for a mistake.

For the modern retailer, this current economy will be the most difficult they have faced in almost half a century.

 

 

 

Economic News

 

Inflation remains the big topic of the day, with Japan registering an annual inflation rate of just 2.6%. The lowest of any of the G20 nations.

While here in the US, the Federal Reserve looks committed to bringing our inflation rate down to that level. And we have quite a way to go, as inflation in the United States stands at a stratospheric 8.5%. This week, three of the most dovish Fed Governors, Neel Kashkari, James Bullard, and Mary Daly, all emphasized that they want to see inflation back at the 2% level. And they will keep conditions tight until they achieve their goal. Markets are not reacting well to this news, which is why we see stock futures in the red this morning.

A couple more retailers report earnings today, and both have positive receptions. Apparel maker Buckle is trading higher on their results. And Foot Locker is up big on the announcement of a new CEO. Mary Dillon, the recent CEO of Ulta Beauty, will be taking over the reins at Foor Locker. Wall Street is very pleased with this announcement.

However, the Street is not so happy about the results from John Deere & Company; the big farm and industrial equipment maker is trading lower in the pre-market on their earnings. These earnings make the second quarter in a row that John Deere disappoints.