Consumer-Dependent Businesses Will Face Tough Times Until Unemployment Subsides

by: Research Recap

With the U.S. unemployment rate at its highest in more than a quarter century–and likely to rise further–industries that depend on discretionary consumer spending may not rebound anytime soon, Standard & Poor’s says in a new report.

S&P’s Chief Economist David Wyss predicts that unemployment will continue to climb, reaching 10.6% in mid 2010. “Even with Congress’ extension of jobless benefits and the pace of job losses having slowed since the worst of the recession, Americans will probably remain frugal until there’s a verifiable significant reduction in unemployment–and that could take years to happen. In addition, a still-unstable housing market and concerns that the economy could again falter continue to outweigh any so-called wealth effect that the recent rebound in stock markets may have created. ”

“Retailers (luxury chains, in particular) have suffered most in this environment. Gaming and lodging companies have also taken a hit because they depend on discretionary spending (and, in the case of hotel operators, on business travel). Manufacturers have suffered as well. Apparel companies are generally struggling, and auto makers are facing the reality of annual sales more than one-third off their peak.”

“Luxury retailers such as The Neiman Marcus Group Inc. (Pending:NMG) and Saks Inc. (NYSE:SKS) have taken a somewhat surprising beating, given that their core customer base still has plenty of buying power.”

Simply put, psychological forces that counterbalance the wealth effect seem to have changed even affluent consumers’ spending mentality.

A few bright spots highlighted by S&P:

  • Clothing companies that can rely more on classics and basics are poised to fare comparatively well. For example, Jones Apparel Group Inc., (NYSE:JNY) with its strategy of offering multiple brands over various price points and distribution channels, looks as if it may have right-sided itself. While the company’s sales dropped 8.9% in the first quarter, the decline was far less than its original expectations. Its well-recognized brands in the women’s apparel and footwear segments (including Anne Klein, Gloria Vanderbilt, and Nine West) will likely help.”
  • Procter & Gamble Co. (NYSE:PG) built its product portfolio on the premise of developing and selling more premium products through pricing, packaging and innovation. But as consumers trade down to lower-cost alternatives and private labels in several of the company’s segments (particularly grooming, health care, and beauty) or curtail discretionary spending, Procter & Gamble is increasing its investment in new products, trying to balance its product-value equation, and is continuing to broaden its product mix )Analysts at Jefferies & Co on Nov 11 reiterated their "buy" rating on Procter & Gamble and raised the target price from $70 to $72.)
  • Customers who are trading down have been a boon to Wal-Mart Stores Inc. (NYSE:WMT), a perennial sales leader.
  • The eateries that have done best, relatively speaking, are so-called quick-service restaurants (QSRs) such as McDonald’s Corp. (NYSE:MCD), which has the world’s highest restaurant sales. Clearly, consumers are looking to McDonald’s and rivals, such as Burger King Corp. (BKC), to save money on meals they purchase and eat outside the home.

Goldman Sachs takes a different view, upgrading luxury retailers Saks, Nordstrom (NYSE:JWN) and Coach (NYSE:COH) on Monday.

“We take a more constructive view of high-end retailers and step aside from those in the path of Wal-Mart,” Goldman wrote in a note.