Costs Up, Sales Down – It's Retail Disaster

Includes: SHLD, SWY
by: Justice Litle

Written by Adam Lass, Senior Editor, WaveStrength Options Weekly

How to earn 367% off American Retail’s “Seven-Ten Split.”

“Biggest jump in wholesale food prices in more than a year!”
– Associated Press, commenting on the Labor Department’s latest wholesale prices report

I know that Justice and I have gone on for some length now on the recent rise in agricultural prices. And I now am about to delve into that same topic – again.

By now, you are probably wondering if you have accidentally subscribed to the Farm Report. But hey – it beats another column on car companies, eh?

(Oh wait, here’s an item on cars after all. I was just perusing Chrysler’s list of doomed dealerships. No wonder they are going under: In my area, there are some 25 or 30 outfits on the list that are all within an hour’s drive of each other. Many are mere miles apart, and a few could probably throw rocks at each other on slow days. With that sort of insane saturation, sooner or later, something was bound to bust!)

And Now, Back to the Farm Report…

I have two reports on my desk right now with almost completely contradictory messages. I am talking a real “seven-ten split” here (a technical term I filched from the local bowling league).

The first lauds the fact that there was almost no drop in consumer prices in April. The Labor Department thinks that this is just peachy because it means that we are not locked in a hideous deflationary spiral.

Apparently this has been a real fear in some quarters of Washington, as over the past 12 months, consumer prices have fallen a whopping 0.7%, the largest such drop since late 1956-early 1957.

Be Careful What You Wish For

The same report also brags that there was not so much inflation to be found either. Core prices (which exclude most everything you use on a daily basis, particularly food and gasoline) actually did rise 0.3% in April. And while this was the biggest spike since last July, the bean counters reassure us that 40% of that rise resulted from a huge spike in the Fed’s tax on tobacco.

So far as Washington is concerned, “it’s the best of all possible worlds.”

You know, those guys in Washington really ought to re-read Voltaire’s Candide before putting out such jolly statements. By the end, the kind professor who coins that Pollyannic phrase suffers through bankruptcy, the Spanish Inquisition, the Lisbon earthquake, and syphilis.

The Dangerous Gap

The other report on my desk has the latest wholesale figures, and they are a tad disturbing for all sorts of reasons.

In April we saw a 0.3% increase in overall wholesale costs. This gain was roughly three times higher than expected. Annualize this and you get a wholesale inflation rate of 3.6%. That’s more than enough to completely neutralize the 3.7% drop we’ve seen over the past 12 months.

What’s more, the actual extent of this rise has been disguised by certain internal disparities. Over that same stretch, wholesale crude oil fell 0.1%. (You could be forgiven for somehow missing this, as the refined gasoline sold to retailers actually went up 2.7%.)

The New Luxury Food: Eggs

It’s that old “non-core devil,” food, that is really soaring. Overall it went up 1.5% in April. If you annualize that, you get an 18% rate of climb. But wait – eggs alone went up some 44%. And that’s not annualized. That’s just the jump for April, making for the largest such increase in the past 17 years.

Oh, and just to dot the “I,” as it were, pharmaceuticals went up at an annualized rate of 12.6%, just as swine flu began sweeping through the nation. (What lovely people in that biz. Ah well, this is, after all a capitalist nation, and they certainly have the right to charge what the market will bear.)

For those of us who predict stuff for a living, this is one of those lovely moments in economics when we know for a fact that only one of two things will happen in the near future. We now know one thing for a fact... that in the first third of the second quarter of 2009, American retailers paid more and sold less, both by price and by unit. Simple arithmetic tells you that this means lower profits.

The Worst of All Possible Choices

Going forward, those businesses must do one of three things. They must either lower costs further (not gonna happen), raise their prices (not gonna happen), or admit that they lost their shirts come the next round of quarterly reports (and unless something changes, that is sooo gonna happen).

A few companies that you particularly ought to keep an eye on: Sears (NASDAQ:SHLD) is particularly vulnerable to increases in cotton, wool and synthetic fabric costs, and also Safeway (NYSE:SWY), which will have to start posting “apologies” signs on the egg bins again.

You would be in good company in these positions. The former is already being played short in WaveStrength Options Weekly to the tune of 37% gains as I sit to write, with gains over 118% anticipated in the near future and a final target of 367% lurking just out over the horizon. The latter, I believe is being shorted by my cellmate, Chris DeHaemer.