‘Experiences’ Over Shopping Bags: How Badly Have Changing Consumer Behavior, Inventory Problems Hurt Retail Margins?

Retail earnings season is a distinct period of the regular Q3 earnings season, and it gets underway next week. Major firms like Walmart and Target are set to report. Analysts are already concerned that inflation combined with swollen inventories may present a double whammy for many big-box stores.

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7 min read
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Key Takeaways

  • Retail Earnings Season Begins Next Week, Defining Consumer Demand Ahead of Holidays

  • Investors Check the Receipts for Walmart, Home Depot, Target, Lowe’s, Macy’s

  • Inventory and Inflation Concerns Have Dogged Stores in ’22, and Some Cut Their Outlooks More Than Once

Shawn Cruz, Head Trading Strategist, TD Ameritrade

If you’d rather spend your disposable income on a trip or meals out over the holidays, that’s bad news for big-box and department store retailers as they come into the spotlight during “retail earnings season” starting next week.

But how important will Q4 be? Current consumer trends appear to favor “experiences” over “things,” and you don’t have to go far to hear about it.

When Uber’s (UBER) CEO Dara Khosrowshahi appeared on CNBC November 1 following the company’s strong earnings report, he said, “The U.S. consumer remains strong, and they are moving a bunch of their spending from retail to services.” Uber’s “mobility” business was surprisingly solid in Q3, he added, as many people visited restaurants and other entertainment venues.

Companies specializing in long-distance travel echoed UBER’s observation about spending. “The travel recovery continues as consumer demand shifts to experiences,” said Delta Air Lines (DAL) CEO Ed Bastian in the company’s recent earnings press release.

If Khosrowshahi, Bastian, and many analysts making similar observations are correct, that’s not necessarily good news for the retail sector, which reports the bulk of its earnings over the next two weeks. No one will ever mistake the aisles of Walmart (WMT) or Target (TGT) for an exotic vacation destination or a fine dining experience.

That said, some big retailers, including WMT, appear to be looking under the seat cushions for revenue from elsewhere as the traditional retail business sags. For instance, WMT got into the streaming video business earlier this year under its Walmart Plus membership banner.

Could Slower Hiring Be a Negative Harbinger?

Earnings season for the biggest stores comes after many retailers trimmed holiday-season hiring.

WMT plans to hire just 40,000 part-time workers versus 150,000 last year. Other major retailers apparently hiring fewer season employees include Dick’s Sporting Goods (DKS) and Macy’s (M), according to Women’s Wear Daily, a trade journal. TGT and Amazon (AMZN) are keeping seasonal holiday hires at the same level as last year. However, AMZN put a freeze on corporate hiring last week due to what it said were “uncertain” economic conditions.

It’s not a slam-dunk, but less hiring ahead of the holidays doesn’t suggest huge shopping demand.

When the retailers report, holiday demand will likely be a prime topic. So will inventory. Over the last few months, many retailers have struggled with this aspect of the business after they ordered heavily to meet their expected post-pandemic demand. However, as supply chain snags also eased, that also contributed to the pileup of goods. Overstocked inventories have driven a lot of price cutting, which should pressure Q3 profit margins.

However, the exact impact of inventory and price cuts could be hard to forecast. It will be a company-by-company issue that could drive individual stock prices more than the sector as a whole.

Other questions investors likely want retail companies to address include:

  • Are high wholesale prices pressing margins, and if so, will the higher prices be passed along to consumers?
  • How “elastic” is consumer demand? Are customers willing to open their wallets a bit wider to buy products at higher prices?
  • How are “low-end” consumers doing versus “higher-end” ones? Meaning are cheaper stores like Dollar Tree (DLTR) and WMT doing a better job keeping customers than higher-end retailers like M and Nordstrom (JWN)?
  • Do executives expect a recession in 2023?
  • Is weakness in China a major issue now or in the future as that country wrestles with COVID-19 and relations between the United States and China worsen?
  • Speaking of China, has there been significant improvement in the supply chain picture since the end of Q2, and have companies with large inventory buildups made progress working them off?
  • What about outlier sectors, such as pets? Some analysts think pets could be a leading retail subsector this earnings season.

Setting the Seasonal Tone

Before checking individual retailers, remember that retail earnings are a special kind of animal. People often talk about retail as a monolith, but the industry is many different things depending on what the company sells and how it sells it. A retailer like WMT caters to lower-income customers seeking everything from groceries to grass seed. You’re not going to find those things at Macy’s on Herald Square in Manhattan, which attracts an entirely different customer base. In hard times, discount retailers frequently outperform luxury outlets. When things improve, it can be the opposite.

AMZN, one of the largest retail companies, already reported, so it sheds some light on what the rest of the sector might reveal. It’s almost like two companies because its Amazon Web Services (AWS) is generating tons of recent growth from its cloud product. Growth slowed in AWS last quarter, meaning relatively soft results on the consumer side didn’t get the cover they usually do from strength in the cloud. AMZN plunged 13% immediately after the company released earnings, owing partly to a lower-than-expected forecast for Q4 revenue growth.

AMZN benefitted from pandemic-related shopping demand. Now that customers are back to shopping in person, the company is struggling in retail and trying to cut costs on that side of the business. Results of a second “Prime Day” promotion last month didn’t impress retail analysts and the trade media. Nevertheless, AMZN’s executives sounded positive about the holiday season ahead.

“We’re ready to roll,” Chief Financial Officer Brian Olsvasky said on the Q3 earnings call with analysts. “We’ve got the best selection we’ve ever had…we’re very optimistic.”

But in his very next sentence, he trimmed the sails, saying, “We’re realistic that various factors weigh on peoples’ wallets, and we’re not quite sure how strong holiday spending will be versus last year. And we’re ready for a variety of outcomes.”

That might be a good way to sum up the retail industry in general as the holiday season begins. It’s not a year when there’s an obvious downturn like 2008. Jobless rates are at historic lows and consumer spending has been resilient despite inflation, according to many companies reporting Q3 earnings in different sectors, including credit card merchants.

On the other hand, there’s that “experiences over products” mentality the DAL and UBER executives spoke about, plus plenty of concern about a possible recession. We’re also not out of the woods on supply chain issues, with China still in “zero-COVID” mode and many factories shut down. AAPL announced last weekend that its iPhone production in China is slowing due to the shutdowns, which could also have a negative impact on holiday shopping if people can’t get the phones they want.

Walmart

Earnings Date: Walmart (WMT) is expected to announce earnings the morning of Tuesday, November 15.

Previously: WMT topped analysts’ earnings and revenue expectations and reiterated its second-half outlook for 2022. Sales rose more than 8%, helped by the company’s grocery division as customers flocked to the discount retailer for lower-priced food. Same-store U.S. sales grew 6.5%, a better-than-expected pace, but online sales growth flagged.

What to Watch: WMT has around 400 stores in China, making it highly exposed to a slowing economy there and to declining relations between Washington and Beijing. Supply chain issues related to China are also a potential drag. When you look at WMT’s Q3 sales, keep in mind the impact higher inflation can make on sales growth as it can make revenues look better than they really were. It’s important to distinguish what’s organic from what’s inflation related. This is true across the retail space. Also, keep an eye on WMT’s apparel business, which has been soft, and watch inventories overall, which were up 25.6% in Q2 versus a year earlier. Any sign of improvement there could suggest WMT is finding a way to get out from under its excess merchandise issues that could slow its pace of markdowns.

Target

Earnings Date: Target (TGT) is expected to announce earnings the morning of Wednesday, November 16.

Previously: There’s no hiding it. TGT had very disappointing results for the quarter that ended July 30. Its profit fell 90% as the company worked through its own massive inventory buildup and markdowns. Those moves came after TGT lowered its guidance twice ahead of the earnings report. On the plus side, TGT did say operating margins could improve in the second half of 2022, reaching around 6%. They were 1.2% in fiscal Q2. Inventory at the end of Q2 topped $15 billion.

What to Watch: How has TGT performed on inventory over the last three months? Is that huge buildup a bit more manageable now? And is the company still expecting that same kind of operating margin improvement? One potentially helpful thing for TGT over WMT is its slightly more affluent customer base, which may be more able to handle this year’s stubborn inflation gains. Some analysts think consumers haunted by inflation will be out looking for discounts this holiday season, potentially putting more pressure on TGT to cut prices. But doing that would potentially hurt margins and earnings.

Lowe’s and Home Depot

Earnings Date: With morning releases for each, Home Depot (HD) is expected to report on Tuesday, November 15 and Lowe’s (LOW) is scheduled for Wednesday, November 16.

Lowe’s (LOW): The last time Lowe’s reported, it was a mixed bag. Do-it-yourself (DIY) sales suffered, but sales to professionals and contractors looked solid thanks to company loyalty programs. However, the DIY cohort is more important for LOW than for HD because HD is more of a contractor destination. The company guided toward the low end of its expected range and said the DIY side should improve in Q3.

Home Depot (HD): Things looked rosier at HD in Q2 than at LOW. Sales and earnings per share both beat expectations, and the company forecasted strong guidance amid firm home improvement demand. Obviously, the question is whether that still holds true as consumers struggle with inflation. Same-store sales year over year beat analysts’ expectations in Q2 with a nearly 6% rise, but HD hinted that could be hard to match in coming quarters. For both LOW and HD, there’s concern that the burst of pandemic home improvement demand amid people being stuck at home and government stimulus might be winding down.

Macy’s

Earnings Date: Macy’s (M) is expected to report on the morning of Thursday, November 17.

Previously: When M reported in August, executives warned that consumers weren’t in as good shape as they’d previously been and warned about pressure on the apparel business. In response, M is among many retailers that have been “discounting furiously,” according to a recent Wall Street Journal article. It faces falling consumer demand amid rising inflation.

What to Watch: Is M benefitting as people go back to the mall amid falling COVID-19 cases? If so, perhaps it can help the apparel business do better than some analysts expect, though the impact of discounting could make it hard for the company to gain on margin.

Other Competitors

Macy’s competitor Kohl’s (KSS) also is expected to report November 17. It’s been facing its own challenges for months, including a rejected sales offer this summer from Franchise Group. Last time, KSS cut guidance for the year, saying middle-class shoppers it attracts have been suffering due to inflation. Could it be more of the same next week when KSS reports again? Quite possibly. 

KSS was back in the news this week when it announced its CEO Michelle Gass would leave the retailer in early December. KSS put an interim CEO in place and said it would search for an executive to fill the position over the longer term.

Discount retailer Dollar Tree (DLTR) cut its guidance the last time it reported, citing customer frugality. It’s expected to report the morning of November 22.

Things might be even worse for many smaller and midsize retailers facing undercutting on prices from major retailers, The Wall Street Journal noted.  It suggested companies like Bed Bath & Beyond (BBBY) and Tuesday Morning (TUE) face “rocky” holiday seasons ahead.

“Rocky” also could be the word to describe retail sector stock performance as a whole over the last few months (see chart below). Could the holiday lights make everything feel brighter? We’re about to find out.

SEEKING SANTA. There has been little but rocks in the retail sector’s stockings so far this year, as the year-to-date chart of the S&P Retail Select Industry Index ($SPSIRE—candlestick) chart above reveals. Data source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Happy trading,

Shawn


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Key Takeaways

  • Retail Earnings Season Begins Next Week, Defining Consumer Demand Ahead of Holidays

  • Investors Check the Receipts for Walmart, Home Depot, Target, Lowe’s, Macy’s

  • Inventory and Inflation Concerns Have Dogged Stores in ’22, and Some Cut Their Outlooks More Than Once

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