Retail: Q1 Recap and Q2 Outlook

By Rob Plaza

Most retailers have reported first quarter results.

• Investor expectations were at extreme lows coming into 2009, and retailers were able to beat those low expectations. This enabled retail stocks to outperform the broader market.
• The upside on the bottom line was due primarily to cost cuts. Gross margins were still unimpressive.
• For most of the industry, sales were down significantly year-over-year. But, the decline in sales was at a slower rate than in the second half of 2008.
• Retailers that actually increased sales were Carter's (CRI), which sells baby apparel; O'Reilly (ORLY), which sells auto parts; and 99 Cents Only (NDN), which is a discount store.
• The retail stocks that outperformed within the group were the lowest priced stocks with the worst-looking balance sheets.
• The laggards were the defensive retailers like supermarkets and wholesale clubs and those with the best balance sheets.
• The stock market action was bullish for companies that reported good news, and it was forgiving of those companies with disappointing results or soft guidance.

Looking ahead to the second quarter, retailers will have a more difficult time repeating their first quarter performance.

• The primary theme on retail conference calls was caution. Management's second quarter guidance -- if offered at all -- was conservative. Several retailers indicated that sales in the first half of May was trending weaker than April.
• As a group, retailers do not expect the consumer to rebound in the second half of the year. Retailers are reducing inventory levels to accommodate a lower level of sales.
• There seems to be a general feeling that consumer spending will not return to levels of a few years ago anytime soon.
• Unemployment is climbing and wages are not. That is not a recipe for higher consumer spending.
• Year-over-year comparisons in the second quarter will be difficult because of the last year's stimulus checks.
• While gasoline prices are down 36.5% from last June, gas prices have increased 44% year-to-date, including 22% in the last month. Retailers will not perform well in an environment of rising gasoline prices.

All told, we believe investors should remain careful when investing in retail stocks. Retail stocks have benefited from low expectations and institutional money betting on a recovery in the second half of the year. If that second half rebound does not materialize, those institutions will jump out of retailing stocks as fast as they got in. That selling could cause retail stocks to give back most of their gains from the first half of the year.