The National Retail Federation expects sales to increase by 4.1% this year over the previous holiday season. This is a mixed bag for retailers who see between 25-40% of their total annual sales in the month following Thanksgiving. Sales increased 5.6% to $563 billion last year, roughly in line with growth in 2010. The 4.1% increase would mean total sales of around $586 million but a pace of growth more than a percent lower than last year.
Retailers have already planned for lower expectations with increased fees for layaway service and aggressive price-matching programs. Online sellers have increased offers of free shipping to draw shoppers away from traditional brick-and-mortar stores.
While shares of the Consumer Discretionary Select SPDR (XLY) have outperformed the S&P 500 over the last month, there are several signs that point to a negative surprise this holiday season. Investors may want to position for weakness in retailers when the markets open after Thanksgiving. Look for strength in online sales and stronger brand names in traditional retailers.
Strength in Consumer Sentiment may not last
Reports on consumer confidence and sentiment have generally come out favorably over the last few months. The Michigan Consumer Sentiment Index rose in October to its highest level since September 2007 and the Expectations Index component increased over the previous month. The positive headlines have helped to support consumer discretionary despite larger macro-related headwinds. This environment may be short-lived on several signs of weakness in retail.
Workers at Wal-Mart (WMT) walked off the job last week in a series of strikes planned through Black Friday. While the company has shrugged off the strikes so far, the possibility exists for some significant disruptions when the stores open at 8pm on Thanksgiving. With domestic employment of 1.4 million, the company is the largest private employer in the United States and accounts for almost a full percent (0.82%) of total national employment. A significant drop in sales at Wal-Mart could dramatically affect sentiment on retailers.
Retail sales fell in October for the first time in three months on weakness in auto sales and electronics. The surprise drop in sales reverses three months of increases and marks the fourth month of weakness in the last seven. According to data from the census bureau, unadjusted retail sales through September registered a gain of 5.6% from the previous year, well off of the 8.2% gain last year and the lowest since 2009.
The biggest overhang to sales this season, besides the general economic doldrums, could be from the Superstorm Sandy. The economic impact from the storm is already coming through in data with a jump of 78,000 in initial claims for unemployment to its highest in 18 months. While most of the impact should be temporary and the reconstruction may add to growth in the first quarter of next year, the near-term affects could seriously diminish sentiment for east coast shoppers.
Online growth to continue
In contrast to slower sales growth overall, online sales are expected to increase by 12% over last year to $95 billion. Retailers positioned in the online space will not only benefit this year but also as sales online continue to grow as a percentage of total sales.
Few are better positioned in the online space as Amazon (AMZN). The $108 billion behemoth reported an operating loss of $28 million for the third-quarter though shares rose on the outlook for holiday sales. The loss was largely attributable to a 28% increase in operating expenses as the company moves aggressively to open more fulfillment centers around the world to decrease shipping time. The price multiple on the shares has always confounded analysts, but the company continues to see high revenue growth and an increasing share price. In a move that could boost traffic, the company recently released that it would announce new Black Friday deals on its website every day until Cyber Monday.
Online marketplace, eBay (EBAY) should not only benefit from those looking for cheap deals but also from increased use of its PayPal payment service. Further, the company sees a large percentage of its revenue from overseas and is relatively insulated from weakness in domestic sales. The online marketplace and e-commerce giant met expectations for revenue on the third quarter with a 23% jump in sales at PayPal and an 11% increase in marketplace sales. The company recently announced its return to the Chinese market with a partnership with fashion retailer Xiu.com to manage logistics on U.S. sales. Shares trade for 16.1 times earnings, just over the five-year average of 14.0 times.
Traditional retailers face headwinds
Besides trouble with striking employees, Wal-Mart has been aggressively pushing its price match guarantee for the holiday season. While the guarantee may bring in incremental revenue, it could be at the expense of margins as the company cuts prices on some products. Even after a 10% drop over the last month, the shares still trade for 14.0 times trailing earnings, above the five-year average of 13.2 times.
I highlighted Coach (COH) on October 15th as a great play in the apparel sector on valuation and brand strength. The shares are down 1.7% on weakness in the general market. North America and China continue to see strong sales and the company recently completed its acquisition of retail businesses in Korea and Malaysia. The company's operating margin of 31.7% is above peers in the group while the trailing price-earnings of 15.3 is well under the industry average of 20.5 times.
While the Gap (GPS) may have a comparatively strong brand in its flagship, Old Navy and Banana Republic stores, the shares have doubled over the last year. The stock price is down 7.4% since I warned investors about valuation in October but it still trades at a relatively expensive 16.4 times trailing earnings. The operating margin of 10.3% is about average for the group but well below that of Coach. The company's share buyback program of $1 billion should help to support the price but investors may want to look for better value.
While retail sales should increase this year over last, it is the pace of growth on which the markets will be focused. This year's growth looks to be slower than over the last few years and several signs point to a surprise on the downside. With the overhang from the fiscal cliff and general economic malaise, a poor showing on Black Friday could send share of retailers down sharply. Investors may want to position their portfolios in stronger names and those that can benefit from stable growth in online spending.