While the U.S. avoided going off the Fiscal Cliff for now, a more immediate challenge might start to hit a number of leading retailers, and that is the 2% jump in payroll taxes. Many consumers just received their first paycheck of 2013 and saw a noticeable difference since a previous payroll tax "holiday" was allowed to expire. A recent Reuters article suggests that roughly 160 million Americans will be impacted by this tax increase, and estimates that it will cost the average worker about $700 per year. This is money that is not going to be spent elsewhere and that can really add up when you multiply even a small monthly paycheck difference by about 160 million workers. The Reuters article states that the "pain will trickle through the economy over the next few weeks."
This payroll tax increase might lead to reduced consumer spending and lower confidence in the coming weeks. A number of retailers and restaurants could be hit hardest and feel a sudden downshift in consumer spending. Lower-income and middle-class consumers might be most likely to reduce their spending by the same amount of their now lower paychecks. That means retailers who focus on the middle class like Target (TGT) and Wal-Mart (WMT) might already start feeling the impact, especially since low- to middle-class consumers tend to spend what they earn. With less to spend, these companies seem destined to be directly impacted. A company like Starbucks (SBUX) might also be impacted soon as consumers rethink their spending habits and possibly cut back on that extra expense for a half-pump mocha decaf latte.
Wal-Mart CEO Mike Duke has already hinted that holiday sales might have been impacted by the year-end debate on the Fiscal Cliff, and the payroll tax hike could be another blow in the first quarter, which is a historically weak period for retailers. Target has also been indicating a potentially weak holiday season as it announced that November same-stores sales fell by about 1%. If holiday sales were not strong before a payroll tax hike, just imagine what sales might be like when consumers get credit card bills in January just as they begin to realize their take-home pay has dropped.
Target shares were trading around $64 in November, but now trade around $60. Wal-Mart shares were trading above $72 in November, but now trade for about $68. Both of these stocks might have already priced in a disappointing holiday sales season. However, the shares might not have priced in the potential impact of the payroll tax hike. If consumers do cut back on spending, these companies might announce weak holiday sales, but also disappointing guidance for the current quarter. Weak guidance is what might drive these stocks even lower in the coming weeks.
By contrast, Starbucks shares have been rising from about $45 in November to around $55 recently. That strength might be masking what is to come, and that could be weaker sales in the United States due to the payroll tax hike. Although Starbucks serves people of all income levels, a specialty drink that costs $4 or $5 might be one of the first discretionary expenses that middle class consumers reduce or eliminate. If so, Starbucks could be a likely candidate to announce weak guidance for the first quarter. Plus, the stock is not cheap. Analysts expect the company to earn about $2.16 per share for 2013. That puts the price to earnings ratio at about 25, which is considerably higher than the average of 14 times earnings for the S&P 500 Index.
While all these companies have solid business models, the impact of the payroll tax hike does not appear to be priced in yet. As the Reuters article mentioned above states, the pain could start being felt over the next few weeks. After these stocks adjust to the new levels of pay in America, it could be a much better buying opportunity for investors to consider in the coming weeks.