The retail sector has seen a steep selloff this year, and upcoming first-quarter earnings may offer little relief. Still, what management teams say about the back half of the year could matter more for stock performance.
Earnings season has already gotten underway, but reports from a number of major retailers aren’t due out until mid-May, as these companies often operate on a fiscal year, reflecting the importance of the holiday shopping season. And though the key fourth quarter was a strong one for many stores, worries about inflation and consumers’ shifting priorities have hit the group hard. The SPDR S&P Retail exchange-traded fund (XRT) is down just over 22% year to date, outpacing the broader market’s slide.
“Professional investors don’t believe that inflation can be tamed without destroying economic demand; that’s why you’re seeing discretionary stocks under so much pressure,” says Quo Vadis Capital President John Zolidis.
Expectations aren’t high going into the reports. Inflation is at multi-decade records, pushing up the cost of essentials like food and fuel, and consumers seem to be directing more of what discretionary funds remain toward experiences that were largely on hold during the pandemic. Government data from March, the latest available, showed that while consumer spending increased at a strong clip, that was led by services like travel and dining.
If those factors weighing on demand aren’t enough, there’s the supply side of the equation.
“Most people would have expected supply chains to improve and prices to have moderated by now, but multiple [factors like] the Russian conflict in Ukraine and the shutdowns related to China’s zero-Covid policy have pushed that out, and inflation is here for longer,” says Mark Giambrone, head of U.S. equities at Barrow Hanley Global Investors. “Investors really need to be selective.”
Barron’s has argued before that retail is once again a stock-pickers market, even if dour sentiment will likely weigh on the group near term. Yet with so much pessimism baked in, the real question becomes whether or not to hold out hope for the second half of the year.
“We do think it will be a challenging earnings season…but we’re less focused on absolute earnings and very focused on commentary; that will move these stocks,” says Miramar Capital Founder and Senior Portfolio Manager Max Wasserman. “If commentary shows signs of recovery…there’s the potential for tremendous asymmetrical return” for companies that have sold off.
Of course some stocks, like the big box retailers, have held onto their outperformance, and given their massive size, their results will provide crucial insights into the ongoing health of the consumer.
Wasserman concurs, saying that Walmart , for all its advantages, will be pressured because about 50% of its revenue comes from food. That’s a low margin business in general, and could be squeezed further by rising transportation and labor costs. Walmart of course has the scale to absorb such a hit better than most, but that will be a key area of focus as investors try to parse the impact on smaller players.
By contrast, “about 95% of Target’s sales are fulfilled by its stores, and that’s 90% cheaper than shipping,” Wasserman notes. He also likes that Target has created stores within its stores thanks to partnerships with brands from Ulta Beauty (ULTA) to Walt Disney (DIS) and Apple (AAPL). “Walmart and Target are both great companies, but Target trades at a cheaper multiple with higher margins and less reliance on food.”
Yet no matter their results, if Target and Walmart see ongoing resiliency among consumers, it could go a long way in reassuring investors that the back half of the year holds promise.
Indeed, Walmart struck a more optimistic tone than bears expected after its fourth-quarter results in February, and ultimately many other retailers followed suit with fairly strong results and forecasts of their own.
While the Russian invasion and spiking gas prices have subsequently muddied the picture, if Walmart can again ease fears about its core lower-income customer, it would bode well for other discounters—as well as the broader consumer-spending driven economy.
Dollar stores and discounters can get squeezed if their core consumer spends less, but they can also benefit from people trading down to their products in the hunt for value. Historically, they’ve been a winner in leaner times, and if leaders like Dollar General (DG) reiterate the upbeat outlook they provided last quarter, that should calm some nerves.
Things look trickier in apparel, where supply chain bottlenecks have been more severe, as have a lack of tourism and greater restrictions overseas—as evidenced by a recent sales warning from Gap (GPS). That doesn’t mean there won’t be winners, but many face a more uphill battle.
“It really depends on the segment where the apparel retailer competes,” says Zolidis, noting that companies that cater to a higher-income customer, like lululemon athletica (LULU) or those with tailwinds such as the ongoing demand for athletic goods and gear, like Academy Sports & Outdoors (ASO), look less exposed to inflation worries.
“For the specialty apparel and teen retailers, it’s going to be company-specific about whether they have the right product,” he says. “People are most concerned about the lower-income customer who benefitted the most from stimulus last year [and for whom] inflation and gas prices are more of a headwind.”
Of course, retail is just one piece of the puzzle: Recent data shows that consumers are once again eating out and taking vacations. Nonetheless the upcoming earnings season will be a key test of the resiliency of Americans’ wallets, and by extension the health of the overall economy.
Write to Teresa Rivas at firstname.lastname@example.org