(Source: Business Wire)
Fitch Ratings expects that the 2008 holiday season will be extremely challenging for retailers and could be the weakest season over the past two decades. Real retail sales turned negative in the back to school period for the first time since 2001 and are expected to remain negative for the balance of 2008. This is particularly significant for the department stores as well as specialty apparel and electronic retailers as the fourth quarter represents about 30% of sales and up to 50% or more of operating earnings for these companies. Promotional activity will be substantial and broad based to drive customer traffic and clear excess inventory.
For 2009, Fitch expects that these trends will continue as consumers curtail discretionary spending and look to maximize value. Comparable store sales growth for operators selling clothing, home related goods, and other discretionary categories is expected to continue to be negative while those companies that have built a strong value perception and have strong private and exclusive brand offerings will outperform their peers. While the weak sales will be geographically broad based, sales pressure will be more acute in those markets most impacted by housing and job related weakness. Similar to the 2008 holiday season, promotional activity is likely to be prevalent as retailers look to stimulate demand and clear overstocks.
This view is based on Fitch's outlook for consumer spending which is expected to further decline through the fourth quarter of 2008 and into next year. The growth in personal consumption expenditures is projected to be -1.6% in 2009 and the rate of growth is expected to remain below trend into 2010. Consumer's wealth, incomes and capacity to borrow are being constrained by rising unemployment and job uncertainty, higher cost and reduced availability of household credit and falling real estate and equity prices. These negative pressures will far outweigh any benefits consumers get from a decline in energy and commodity prices.
As a result, Fitch has recently taken a number of negative rating actions and expects negative rating pressure for its U.S. retail coverage in 2009. This is reflected by the number of Negative Rating Outlooks across the portfolio with 10 companies or 36% of the portfolio having Negative Rating Outlooks compared to 15% in the year ago period. Negative rating activity is more likely for retailers selling discretionary products such as department stores and specialty retail, where the Negative Outlooks are concentrated.
KEY RETAIL TRENDS IN 2009:
Fitch expects retailers will continue to focus on several ongoing initiatives in 2009 which includes maintaining or increasing market share by emphasizing their value proposition, managing profitability in the face of declining sales, and preserving liquidity and maximizing capital efficiency. In addition, Fitch expects further retail consolidation as retailers that do not manage these initiatives effectively are forced to reduce their retail footprints or exit the market.
Emphasizing Value to Gain Share
Value oriented offerings will be the focal point as retailers try to capture more share of the consumer's shrinking wallet. Promotion and pricing will be prevalent across the spectrum of retailers in 2009. Key beneficiaries of this shift in consumer behavior will be the discount formats, particularly those selling food such as Wal-Mart and Costco. In addition, companies that have built a strong value perception and have strong private and exclusive brand offerings should also outperform relative to their peers.
Preserving Operating Margins - Inventory and Operating Cost Management
Further cost cutting measures will be another significant area of emphasis for retailers as they look to offset margin compression from heightened promotional activity, mix shifts to lower margin products and lower leverage of fixed costs. Inventory management, supply chain efficiencies, labor productivity and other operating costs are expected to continue to come under increasing scrutiny.
Some companies in the more challenged department store and specialty retail segments such as Macy's, Kohl's, and Gap have done a good job of managing gross margins despite the weak sales levels. In general, comparable inventory levels are down, but weak holiday sales will necessitate higher levels of promotional activity. In addition, even those retailers that have appropriately managed inventory levels are likely to be impacted as competitors with excess inventories or those liquidating use promotions to clear store shelves. In 2009, Fitch expects inventory planning will be challenging and a key focus for companies. Companies with shorter lead times, such as Best Buy and Kohl's, will be better positioned to react quickly than those, such as the luxury retailers, with lead times as long as six to nine months.
Companies have been cutting operating expenses and certain companies, such as RadioShack and Limited Brands, have been able to cut costs as an offset to gross profit weakness. However, given the significance of the expected revenue declines in 2009 operating margin deterioration is likely to accelerate and profit declines may be substantial.
Liquidity Focus and Capital Efficiency
Another key area is preserving liquidity and maximizing capital efficiency. As external availability of credit is challenged, internal and committed external sources of liquidity are critical to meet upcoming commitments. For retailers in Fitch's coverage, long-term debt maturities are relatively moderate with around $40 billion maturing over the next three years out of a total of almost $150 billion outstanding.
