Feature
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SATURDAY, NOVEMBER 19, 2011
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Sorry, Santa Won't Be Staying
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By JACQUELINE DOHERTY
The surge in consumer spending has been propelled by a reduction in Americans' savings rate. The trend won't go on forever. Neither will the rise in retailers' stocks.
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Santa came early to investors in retail stocks this year. The shares have easily outpaced the broad market, propelled by strong earnings and sales, despite high unemployment and dour consumer sentiment. But as Black Friday and 2012's dawn approach, retail stocks face a tougher time.
Comparisons get much more difficult, and the positive trends that boosted spending at retailers by almost 6%, on average, this year might not recur. At best, the stocks could respond by stalling for the next few quarters. At worst, they could be setting up for a nasty fall.
CONSUMERS FINANCED their 2011 spending spree by sharply reducing their savings rate. A reduction of equal size this year is highly unlikely; it would bring savings down to almost nothing in an environment where the prices of homes—most Americans' largest asset—are depressed, stocks are volatile and consumers remain concerned about the economy, their personal finances and their jobs.
"It's not a sustainable condition," asserts Neil Dutta, U.S. economist at Bank of America Merrill Lynch. "I think consumer spending will soften next year."
However, prices at the pump are about to creep higher again; just last week, oil shot above $100 a barrel for the first time since mid-July. In addition, consumers could be facing higher federal taxes next year as politicians try to boost revenue to help trim the federal budget deficit. In a number of ways, the situation is exactly the opposite of what Barron's found last year when, in an article that proved accurate, we predicted that spending during the Christmas season would be surprisingly strong ("Off to the Mall," Nov. 22, 2010).
While yes, Virginia, Santa will arrive this year, holiday sales may come in at the low end of, or slightly below, expectations. The National Retail Federation has one of the most anemic forecasts around. It expects holiday sales—excluding outlays for autos, gasoline and meals at restaurants—to rise 2.8%, compared with 5.2% in 2010.
"Though several economic indicators paint a solid picture for the holiday season, including 14 consecutive months of retail sales growth and a substantial reduction in household debt, continued consumer uncertainty over the stock market, higher gas and food prices, fiscal policy and sputtering job growth will impact spending," says an NRF news release. And it observes: "Additionally, the substantial year-over-year gains for the 2010 holiday season will create more difficult comparisons for retailers to achieve this year."
Most of the analysts Barron's spoke with believe the market anticipates a rise in sales of 3% to 4%. One of the more optimistic estimates comes from Customer Growth Partners, a consulting and research group, which predicts a 6.5% rise, thanks to pent-up demand and a financially healthier consumer.
Even slight disappointments might have a big impact because the stocks of many retail chains—especially those catering to the wealthy—have rallied sharply, inflating their valuations. The Standard & Poor's retail index is up 14% over the past 52 weeks, while the S&P 500 has gained a mere 3%.
So far the rise in retailing stocks has been accompanied by increasing expectations for strong earnings growth. The profits of retailers in the S&P 500 are expected to climb 18% this year but just 14% in 2012, according to Bespoke Investment Group.
"Retail stocks went to all-time new relative highs," says Jim Paulsen, the chief investment strategist at Wells Capital Management. Retail shares have outperformed the broader index for most of the past three years. While he believes that consumer spending will remain strong next year as job growth and real incomes improve, he maintains that retail stocks could still underperform because they have priced in so much potential good news. And, if any negative surprises crop up, the shares could really slump.
Paulsen is recommending that investors buy shares of groups that have been disappointing this year, such as industrial, basic-material and emerging-market stocks.
THE STOCK-MARKET SHOWING by clothiers and retailers catering to the well-heeled has been particularly impressive. Over the past 52 weeks, Ralph Lauren (ticker: RL) has surged 41%, Coach (COH) has jumped 17%, while Tiffany (TIF) has advanced 35%.
As their shares have risen, their price/earnings ratios have improved, too. Ralph Lauren's stock, recently at $148, trades at 18.5 times analysts' profit estimate for calendar-year 2012. Tiffany shares, around $75, are in the same neighborhood, with a multiple that sparkles at almost 18 times. Coach, at $61.47, is slightly more reasonable with a 16.2 multiple, but the multiples of all three are far above the S&P 500's 11.8.
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Well-positioned retailers focused on middle- and lower-income consumers have also fared well. Costco Wholesale (COST) has jumped 22% over the past 52 weeks. Bargain shoppers love TJX (TJX) and its shareholders do, too, after its stock's 30% increase. And Dollar Tree (DLTR) and Dollar General (DG) may cater to those with low incomes, but they have given shareholders rich rewards, with the stocks up 39% and 32%, respectively.
Given this preholiday euphoria, caution—if not outright profit-taking—is warranted. "Everything that we look at points to a deceleration here, and the risk of external shocks has increased," observes Steven Wieting, a U.S. economist at Citigroup Global Markets. As a result, he sees growth in chain-store sales slowing from 4.5%, year-over-year, in the third quarter, to 2.5% to 3%.
Wieting notes that employment improvement has been negligible and that nominal income gains decelerated from a 4.5% annual clip in the first quarter to 3.3% in the third. As a result, consumers have been funding their higher spending out of their savings, a major point of concern for the future.
THE SAVINGS RATE, which hit a high of 8.3% of disposable income in May 2008, has rapidly fallen; it was 3.6% in September, the last month for which data are available. That means that over the past year, consumers have reduced the amount they save annually by roughly $200 billion. And, unless consumers become comfortable again with having little in the bank—as they were four years ago, when real-estate prices were soaring and consumers could tap into the gains by selling their houses or taking out home-equity loans—this isn't likely to continue.
"I think the last three to four months, we've been living on borrowed time," says Colin McGranahan, a Sanford Bernstein retailing analyst. In a recent report, he wrote that the "current 3.6% savings rate appears to be abnormally low, relative to household wealth. While this doesn't necessarily presage a 'reversion to the mean,' it does suggest that the current consumer spending behavior is significantly at odds versus historical norms."
The analyst says that household net worth has a meaningful inverse relationship with the savings rate. And based on the current state of that measure, he estimates that the savings rate should be 5.3%, where it stood in June.
The only time the savings rate was so far below the expected rate was in the mid- 2000s when homeowners were taking equity out of their homes. A return to 5.3% would decrease consumer spending by about $200 billion a year and cut consumer spending growth by 1.8 percentage points.
Bank of America Merrill Lynch's Dutta argues that there are more reasons now than ever before for the savings rate to be higher.
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Boomers need to work longer and save more for retirement. Young people don't believe that Social Security will be around for them, so they need to save more. And, he adds, unemployment is high, so those with jobs may want to save more for fear that they will join the ranks of the jobless.
In fact, it's the rare person who wasn't shaken—and awakened to the importance of having a substantial nest egg—during the 2008-2009 financial crisis, when it sometimes appeared that the global economy would collapse.
Dutta believes that as incomes improve, the savings rate will increase, ultimately to 7% to 8% by 2015. "There's a higher rate of precautionary savings needed," he concludes.
For the spending surge to continue, consumer incomes would have to rise, through higher wages, lower unemployment or both. And while that's possible, it isn't likely anytime soon, given the slow economic expansion widely expected. In fact, after-tax incomes could actually decrease for a while, as local and federal governments continue to scramble for ways to boost revenue.
The tax cuts instituted under former President George W. Bush are set to expire at the end of 2012.
While Congress might preserve the cuts to the lower- and middle- income tax brackets, it's likely that the top bracket may return to 39.6%, versus today's 35%. Polls have shown widespread support for increasing taxes on the wealthiest part of the population, and politicians do like to keep their jobs. But such an increase, warns BOA's Dutta, would drain $50 billion a year from higher-income pocketbooks.
Payroll-tax cuts also are set to expire at the end of this year. If they aren't extended, consumers would have $90 billion less to potentially spend. At the same time, extended unemployment benefits, which increased the number of weeks one can receive jobless payments from 26 weeks to 99 weeks, also could be halted. That would eliminate $40 billion of yearly government payments that have helped bolster consumer spending, Dutta adds.
The elevated costs of gasoline and groceries, at least by historical standards, could also drain consumer purchasing power. After average U.S. gas prices hit almost $4 a gallon in May, they drifted lower for most of the summer, bottoming in early October at $3.42. Since then, prices have plateaued.
The national average at the pump stood at $3.44 last week, but is likely to creep higher now that the price of crude oil is bouncing around $100 a barrel.
Likewise, food prices have been rising this year. In October they were up 4.7% from a year ago.
Kimberly Greenberger, an analyst at Morgan Stanley, downgraded Coach, Tiffany and Nordstrom (JWN) shares recently to Equal Weight from Overweight, after strong runs brought them near her price targets.
Greenberger doesn't recommend exiting from the industry entirely. She has kept an Overweight rating on Macy's (M), which has been gaining market share, thanks to a focus on local preferences. Despite posting strong earnings growth, the chain continues to trade at a price/earnings multiple below the market's at 9.6 times, based on expected $3.16 in calendar 2012 earnings. Greenberger's target on the stock is $35.
RECENT DISAPPOINTING RESULTS at Urban Outfitters (URBN) have sent its shares almost 27% lower this E3WDSS. But, Greenberger wrote in a recent report, the stock's price doesn't reflect the company's five-year 12% compounded annual growth rate per-square-foot story and so is worthy of an Overweight rating. She also likes Ann Taylor (ANN), which she expects to gain market share, but which is down 13% from the start of 2011.
Certainly, pessimism about the retailers' stocks could be early. As the holiday season approaches, spending momentum has continued. Last week, the Census Bureau reported that October retail sales, excluding autos, food and gas were 5.4% above the year-earlier figure. And if consumers keep spending, businesses could become confident enough to hire more people. Last week, for the second week in a row, unemployment claims fell below 400,000.
"You're fighting the tape to be negative on these names," warns Patrick McKeever, an analyst at MKM Partners. Retailers have cut costs and inventories to remain profitable, even in this slow-growth environment, he says.
McKeever, who does expect retail sales to increase 3% to 4% over the holidays, has Outperform ratings on TJX, Target (TGT), Kohl's (KSS), DSW (DSW), and Ross Stores (ROST).
Yes, the tape has been positive for retailers, but only because consumers are spending money they should be saving. That trend soon is likely to end. So, anyone contemplating buying the stocks should heed retailing's ancient maxim: Buyer beware.
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| Recent | 52-Wk | 12-Mo | EPS * | EPS * | P/E* | |
| Company/Ticker | Price | High-Low | % Chg | 2011E | 2012E | 2012E |
| Coach / COH | $61.47 | $69.20 - $45.70 | 17.0% | $3.18 | $3.80 | 16.2 |
| Costco Wholesale / COST | 81.98 | 86.34 - 64.57 | 22.3 | 3.39 | 3.99 | 20.6 |
| Dollar General / DG | 39.06 | 40.71 - 26.65 | 31.5 | 2.29 | 2.63 | 14.8 |
| Dollar Tree / DLTR | 76.27 | 82.49 - 48.51 | 39.4 | 3.95 | 4.64 | 16.4 |
| Family Dollar Stores / FDO | 56.02 | 60.53 - 41.31 | 15.7 | 3.22 | 3.74 | 15.0 |
| Home Depot / HD | 37.62 | 39.38 - 28.13 | 22.0 | 2.38 | 2.72 | 13.8 |
| Kohl's / KSS | 54.97 | 58.00 - 42.14 | 4.1 | 4.48 | 5.23 | 10.5 |
| Macy's / M | 30.42 | 32.67 - 21.69 | 23.4 | 2.77 | 3.16 | 9.6 |
| Ralph Lauren / RL | 148.22 | 164.55 - 101.83 | 40.6 | 6.84 | 8.00 | 18.5 |
| Tiffany / TIF | 74.94 | 84.49 - 54.20 | 34.6 | 3.71 | 4.18 | 17.9 |
| TJXCompanies / TJX | 59.18 | 61.71 - 42.55 | 30.4 | 3.97 | 4.46 | 13.3 |
S&P 500 |
1216.13 | 1,371 - 1,075 | 3.2 | 96.28 | 103 | 11.8 |
*On a calendar-year basis. E=Estimate. |
Source: Thomson Reuters | |||||
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