TKO

Average Joe Isn't Buying: Retail's Future Looks Bleak

Remember that the drop is aggregate - Consumer discretionaries may be very hard hit.

For example;
Consumer staples, which make up most of the retail sales, may have shown a 0.5% decline (for example). Assuming 30% of retail sales are made up of discretionaries, that means consumer staples saw a 0.5% x 70% drop in sales for a weighted drop in sales of 0.35%. Let me put this in perspective - Of the total 1.7% drop, only 0.35% of it is attributable to consumer staples... which make up the bulk of retail sales. So this means the other 30% makes up the other weighted drop of 1.35%. 1.35% = consumer discretionary retail drop x 30% --> Consumer discretionary retail drop = 4.5%.

If your gross profit margins are normally 40% and your net profit margins are 6.5% (Taken from AEO's industry average on Reuters)... doing some reverse engineering, 100M in revenue means 40M in operating profit and 6.5M net profit - or simply, deduct roughly 33.5M from operating profit to arrive at net profit as most of these expenses are fixed (and not tied to cost of goods sold). a 4.5% drop in sales means revenue drops to 95.5M and your gross profit is now 40% x 95.5M = 38.2M. Deduct 33.5M and you now have a net profit of 4.7M instead of 6.5M. A healthy consumer discretionary company suffering a 28% drop in net income is quite harsh. Imagine what company's like ANF are going through with a 24% drop in december year-over-year sales.

The good thing is, however, most of these prominent mid-range to slightly higher-mid range clothing companies such as AEO and ANF are not very highly leveraged -- companies like AEO are actually sitting on a wad of cash. With bankruptcy a very small probability, general economic trends priced in, and an overall very bleak picture that is hard to get any worse, any better than expected results can place significant movement on these stock prices -- There is far more upside than downside.

This is not to say, the news can certainly get worse. But with most of that priced in, it'd be difficult to see significant drops or movements beyond the levels we saw in november. With a technical bottom from panic selling established in the near-term and the worst news priced in fundamentally into consumer discretionaries, both things signal some optimism.

On Jan 11 03:23 PM PastTense wrote:

> "December retail sales dropped 1.7 percent year-over-year, making
> for the worst decline ever recorded''
>
> 1.7% just doesn't seem that catastrophic to me. If business can't
> handle declines that small, they need new management.