Friday, November 28, 2008

Only Black in the bleak, dark and gloomy sense of the word

I'm afraid they may have to rename today. Traditionally known as Black Friday because it was they day that most retailers finally made a profit for the year ('went into the black'), this year I'm thinking there's a little more red flowing than normal. The question of the day: Is that red ink or blood flowing through the mall?

As I do every year, I arose this morning at a time that would have been considered uncivilized anywhere in the country, regardless of time zone. By a little after 3am I was chatting with folks lined up outside Kohl's. I followed that up with a trip to Wal-Mart for their 5am opening, then to Target for their 6am opening, and finally a walk through the mall for Macy's, JC Penney, Sears, Nordstrom and all the specialty stores.

Without further ado, this year's view from the battlefield:
  • People are hurting financially and it's going to show in sales. 75% of shoppers interviewed are cutting back their spending for this holiday season significantly (anywhere from 30-90% cuts). Of the remaining 25%, most were just holding spending equal to last year, and the few who were spending more were generally in their 20s (no mortgage, little debt) and hadn't spent much last year.
  • Consumers are shopping for what's on sale: just having items FOR sale isn't enough anymore. The days of paying whatever you have to just to make sure that a is under the tree for the kids are just plain over. Most consumers were going to multiple stores to buy specific items in each location... and they were shopping fewer stores overall. This, by the way, defeats the purpose of doorbuster sales for the retailers, which are supposed to lure you in and get you to buy some non-discounted items also. The only exceptions to this rule were Wal-Mart shoppers. Wal-Mart management should be pleased to know that only one consumer interviewed in their line had any intention of going to another store after they were done at Wal-Mart. The 'save money, live better' message is resonating well with their consumers!
  • Lines are longer than in previous years, but there is less in the baskets and everything in those baskets is pretty deeply discounted. I was asked by a reporter today if that meant bad margins for the stores, and the answer is only a 'maybe.' I know that JC Penney and other retailers have been trying to increase margins anyway they can, including buying items with discounting in mind. An example would be a retailer knowing that their consumer needs to buy jewelry at a certain price point, say $100. Just like last year, the retailer will have items at that price point, but the quality of the item will be lower this year, allowing them to maintain margins.
  • There's no place like home. Once again, a lot more shoppers than I expected headed directly to the home departments at Kohl's, Macy's and JC Penney. Even though this stuff hasn't been selling well at full price, if you discount it they will buy.
  • Most surprising trend? This year it had to be the lack of a must have item. Sure, parents were buying video games and DVDs for their kids. But only a few parents mentioned the Guitar Hero as something they had to have. GPS units, MP3 players, cheap flat screen TVs were all mentioned as desirable by shoppers... but virtually no one said they'd pay full price to get them.
  • Most bags in the mall? This year it was a tie between Macy's and JC Penney, with Bath & Body Works getting special mention as the most prominent specialty retailer.
  • The winner of the 'You Think This Stuff is Going to Sell Itself?' Award is Abercrombie & Fitch. Apparently the corporate motto is 'Discounts? We don't need no stinkin' discounts.' Unfortunately, based on the lack of traffic and sales in the store, I beg to differ.
  • Biggest fall from favor award goes to Apple. I'm not saying they weren't selling anything, because I'm sure they were, but over the past few years the stores have been packed to overflow on Black Friday. Today? Not so much.

So, what do we do with all this information? I'm going to spend some time this weekend plowing through balance sheets, looking at corporate cash levels, and watching consumers. I firmly believe that today confirms that the holiday retail season is going to be as dismal as advertised, if not worse. I think there might be something to be said for shorting the retail index and pairing that with a long trade for a couple of high quality retail companies. Names to follow.

Friday, November 21, 2008

The New King is a Duke

Congratulations to Mike Duke, the newly named successor to Lee Scott at Wal-Mart. Mike's most recent deployment has been over the international portion of the business. His experience in the firm and in retailing in general will be put to good use heading up the worlds largest retailer.

Although I have to say that the skills that Lee Scott has most utilized over the past three years have been more in the public relations and media arena. It's been all about the old soft shoe... but it's been backed up with action. And for that, I need to add a hearty congratulations to Lee Scott. I know I'm not on his Christmas card list, and in fact seemed to be on Wal-Mart's hit list for a number of years, but Lee, you done good. You fixed the problems. You brought in the right people, let them do what needed to be done, and the results have been worth waiting for. I'm sorry for that time a few years ago when you took a month off and I called for your resignation. It wasn't nice, but I was frustrated. In retrospect, it wouldn't have been the best thing for the company.

Now Lee, go enjoy your retirement. The folks you've put in place will carry on just great. You're leaving at a high point, and you've earned it.

It covers a multitude of sins

It's interesting to me how the earnings reports of some of the best companies are surprising my breathern on Wall Street. Look at Macy's. Look at Dell. Look at The Gap. Look at this recession's poster child, Wal-Mart. Their sales weren't nearly where they needed to be, but the bottom line number was fabulous, just fabulous. The Wall Street Wonks are scratching their heads, trying to figure out how their channel checks could have lead the some wrong.

As I've been saying over and over again lately, in this market it is all about the best operators. Can they control their expenses? Have they looked at every possible option for reducing their Cost of Goods Sold? Are they maximizing their sales per square foot? Have they gotten creative with their marketing, luring people into the stores with low margin stuff, then selling them some attractive higher margin items too?

The best companies know which levers they can pull in bad economic times, and those levers aren't something new to them. The best companies are led by management teams that understand that if the only way you can grow your earnings is through building more stores or selling more stuff, you're holding a pretty weak hand in the poker game that is global capitalism.

In this kind of market, I want to own companies holding 4 aces. These companies exist, but you need to look closely at how they've managed their businesses historically as well as currently. As Warren Buffett has been quoted, it's only when the tide goes out that you see who has been swimming naked. Avoid naked capitalism! Buy companies that have covered their backsides... and yours... well.

Tuesday, November 18, 2008

Ugly. It's all ugly.

How quickly we get to the point where a 1/3 cut to next quarter's earnings just doesn't phase us anymore. Heck, in some cases it's a reason for rejoicing since it isn't worse.

Home Depot rallied on bad numbers. Okay, part of that was because it's a Dow member and the Dow was rallying, but that doesn't account for it all. HD was up 3.6% vs 1.8% for the Dow. Gotta love that kind of reaction to a 31% fall in Q3 profit, even if it was partially because it didn't stink as much as expected.

Today's rally was brought to you courtesy of the letters HPQ. Hewlett Packard was able to pull off good numbers. It can happen folks. Let's see a little more of that. It will be a lot more fun. I promise.

Thursday, November 13, 2008

Cheap is as cheap does

I'm sitting here scratching my head, trying to figure out what it was that caused today's incredible rally toward the end of the day. Maybe there was a hedge fund convention that started at 1pm eastern, mandatory attendance gentlemen, and that let up the selling pressure for a few hours? Or maybe some Mars moved into the orbit of Venus causing an updraft in the positive energy flow amongst the planets and intra-day traders. I've read a couple of articles that attempt to explain it as the reaction to ultra cheap stock valuations, but that explanation makes as much sense to me as the first two ideas I floated.

For stocks to be cheap, there has to be some benchmark to measure them against, whether it is peers, expected earnings, or history. The problem is that I don't think that we really have a clue what earnings are going to be for a majority of companies, the historical basis we're considering is too short (putting them versus the last 5 or 10 years is, dare I say it, just plain stupid - we're in an economic situation that goes back at least 30 years, if not 80 years), and when you put companies up against their peers the only relatively expensive companies are the companies that are actually doing okay in this economic malaise (you know, the only companies that I wouldn't mind owning at this point.)

Case in point: in the retail landscape, it's hard to find a company doing better than Wal-Mart, and they're relatively expensive too. They reported earnings this morning that were a penny better than expected (a huge accomplishment for a company of their size!) Now the headline you might have seen splashed about was that they took guidance down for next quarter, but that was because of a swing in foreign exchange, not because of operational issues. If you take the $0.06 hit that they are expecting from foreign exchange out of the equation, they are actually taking guidance UP for Q4. That is the kind of company I want to own.

Let's contrast that with the reports this afternoon from Kohl's and Nordstrom. They're both good operators: good management, good systems. Crappy sales. To quote my favorite former CIO, you might call the numbers they put up 'dismal and deleterious.'

On the surface they theoretically both beat expectations, but I'd hope at this point that you're looking below the surface. Kohl's actually beat expectations by a penny, but took Q4 earnings guidance down by 1/3. Customers just aren't buying. So is it cheap at 10x earnings? Maybe, if you truly believe that they'll grow earnings at 14% over the next 5 years... but do you REALLY believe that? I didn't think so.

Nordstrom beat recently lowered expectations by $0.02, but that result included a help of $0.03 from non-recurring items that they hadn't included in previous guidance. Or, put another way, they reported real numbers that were a little worse than they guided to a week ago. Oh, and then they put some icing on the cake... they lowered earnings by HALF for Q4. HALF. Hello, Seattle? We have a problem. This is the third time they've taken guidance down this year. And to have earnings looking like something closer to $0.35 for Q4 than $0.70, that's just abysmal. So it's trading at 5.4x times next year's earnings, doesn't that make it a buy? Sure. Go ahead. But use your money, not mine.

Wednesday, November 12, 2008

Socks and underwear

For many consumers, this is probably going to be The Holiday of Socks and Underwear. For most retailers, that’s going to translate to sackcloth and ashes for earnings.

The consumer is facing rising unemployment, higher food prices, tightening credit, and the evaporation of their balance sheets. Consumers are buying food and basics, all other categories have fallen off the proverbial cliff. They’re trading down wherever and whenever possible, and buying on sale when they don’t trade down. The one unknown is how the recent fall in gas prices will adjust consumer spending (down 45% off the July highs, roughly -15% from this time last year), but my best guess is that other concerns will trump it.

In order to entice shoppers into their stores, the bargains have already started. This is partly because many retailers still have fall merchandise to clear so they can get holiday into the stores, and partly because shoppers have proven to not make a move toward their wallets until the signs say 40% off or more. (JC Penney Tuesday through Thursday: 75% clearance merchandise, 15% off everything else in the store. Why would anyone think retailers are desperate?) Bankruptcy clearance sales are putting even more pressure on the ‘healthy’ (or would it be more appropriate to say ‘not yet in horrible trouble’) retailers, as they have to compete with the clearance pricing.

The one safe haven has been discount stores, but even within that group there are the haves and the have nots. Wal-Mart is the poster child for this recession: the one retailer who after three long years of promises and pain had finally gotten its house in order, and at exactly the right time. Wal-Mart’s mix of food and general merchandise (roughly 60/40 consumables/gm) has served it well. Costco and BJ’s Wholesale also sell a mix of products leveraged to consumables, and their performance reflects that. That contrasts with Target that doesn’t sell nearly as much food (41% of what they sell is apparel/home). Dollar stores are also doing well, as is as Aeropostale a teen retailer that specializes in lower priced merchandise that is still similar to the higher priced Abercrombie and American Eagle.

Macy’s and Best Buy reported this morning. Macy’s is managing through this time by not marking down, controlling inventories, and putting out a feel good message (LOVE LOVE LOVE the ‘Believe’ campaign they’re running) as opposed to some of their competitors (JCP noted above) that are really marketing on price. Best Buy told us this is the worst they’ve seen it. Of course, they’re not selling anything that is absolutely vital to the consumers’ survival (despite what kids might say about having to have the newest computer games.)

Surveys are showing that a majority of shoppers are planning on spending less this holiday season than last year. Those purchases that are made are going to focus on value for the money. That doesn’t bode well for gift cards this year, since a savvy shopper can shop the sales, buy a $100 sweater for $60 (or less) and get the mental credit with the gift receiver for having bought a $100 sweater. On the other hand, if you give a gift card $50, chances are you have to pay $50 for it. Although, there are a number of signs of desperation from the retailers that include ‘buy $100 in toys and get a $10 gift card (Fred Meyer… a Kroger affiliate much like a small WMT) and Mattel’s current offer of ‘buy $100 in Barbie paraphernalia (any retailer) and get a $50 Barbie Visa gift card for mom.’

Specifically on stocks reporting Thursday:
* I’m expecting that WMT could beat consensus of $0.76, although since we’re talking about WMT, it should only be by a penny or two.
* Kohl’s has already guided down to the lower end of $0.51-0.56. They’re going head to head with the rest of the department store space, and it’s a very value conscious consumer. They’re a fabulous competitor and have been able to manage costs extremely well historically which is going to be necessary for success going forward.
* Nordstrom. ::sigh:: Nordstrom is going to be painful. All we know is that numbers will be below previous guidance for $0.32-0.37 (consensus was $0.36, now $0.31, and I fear still too high.) Love management, think they’ve got great systems and cost advantages (commissioned based sales staff), but I am concerned that they’re not only missing the aspirational customers but that now their core customers have pulled way back.

Be careful out there.

Monday, November 10, 2008

A bitter cup

As much as I like my cinnamon dulce lattes, it's not hard to see how Starbucks came up with such absolutely abysmal Q4 earnings of $0.01 versus expectations for $0.13. Sure, $0.09 of it was due to restructuring costs, but $0.10 is still a big miss. While management has made some of the hard choices needed (closing 600 underperforming stores, cutting the bloated headquarters staff), I can't help but think that they're still looking at the world through rose colored glasses.

For Howard Schultz to say that Starbucks thinks they're better positioned than other luxury retailers because those luxury retailers (I think he's talking about Saks and Nordstrom) had double digit negative comps while Starbucks Q4 comp was only down 8% in the U.S. Congratulations boys. It certainly couldn't have been because your foo-foo coffee costs $4 versus a $500 dress, could it?

True, cutting those extra stores should help the comps for the remaining stores. And it's also true that making most of the future international stores licensed stores (a.k.a. franchised) uses someone else's capital to grow their business. I'm still stumped at how they can come up with value offerings, sell $100 of gift cards at Costco for $79.99, expect lower comps, and still come up with margin expansion for next year.

I truly wish them the best, but I'm just not sure that the markets are going to buy this cup of coffee until after a quarter or two of taste tests. While I wait, I'll be humming the theme from "Here Come the Brides" (yes, I'm that old)... 'the bluest skies you've ever seen are in Seattle...'

Thursday, November 6, 2008


All I can think about after this morning's retail same store sales release is doing the limbo... you know, the dance where the refrain is 'how low can you go?'

The numbers are miserable. Of all the companies I track, only two had positive comp store sales (comps): Wal-Mart (+2.4%) and Aeropostale (+1%)... and Aeorpostale's comp was below the expectation for +4%. The department stores had it rough, and the higher end stores were hit especially hard. Nordstrom managed to 'beat' expectations for a -12.5% comp by reporting -15.5%. Saks not only had a -16.6% comp, but said that even their (previously?) well-heeled shoppers weren't buying much if it wasn't on sale. That's saying something for a store that targets customers with an income in the top 5% demographic!

Reports today were filled with companies guiding down expectations prior to the release of Q3 earnings, which start next week. Two thoughts on this: first, if you didn't already realize that things have just been getting worse for the consumer you haven't been paying attention; and second, where the HECK have the Wall Street analysts been? I have to say, many times when I've met with those guys and company managements, I've been amazed at how much more I know about the companies and how they're executing in the stores than the headline analyst did. Scary. Get out and get into the malls, boys. It's eye opening! ::rant over::

Anyway, on the 'opps, we did it again... our earnings aren't going to make previously lowered expectations' list are:
  • Nordstrom
  • Macy's
  • Kohl's
  • JC Penney (within range if you include a real estate sale is NOT okay)
  • American Eagle
  • Pacific Sunwear
  • Zumiez

Interestingly, the list of companies affirming guidance or raising guidance is as long, just from different sectors:

  • BJ's Wholesale (gas helped a lot)
  • Ross Stores
  • TJX Companies
  • Aeropostale (the only specialty retailer really performing)
  • Hot Topic
  • The Gap (low sales are okay if you can still make margins)

So what will be come of America's retailers? It's going to be ugly folks. To paraphrase, these are the times that try retailer's souls. My prediction is that within a few years we will have a major contraction in specialty retail. Folks like Abercrombie & Fitch will give up on some of their brand extentions like RUEHL that just aren't working. American Eagle will shutter Martin + Osa. Gap will have to shutter a lot of its retail space. Limited, it's been nice, but can you really make it? Chico's? Coldwater Creek? You're no longer growth businesses, and I'm not sure there's room enough for both of you in this new landscape.

The American consumer has rediscovered frugality, and this time it isn't a phase, it HAS to be religion. I'm just not sure there's a reason to own much beyond the discount stores until more of the pain has passed.