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RETAILERS CHEER AS RISING SALES BOOST EARNINGS

BY MICHAEL BAKER

Click to view table (520k PDF).

Last year was good for chain stores and, by extension, their shopping center landlords. Earnings through 2003 improved across all retail categories. Better still, earnings growth became increasingly top-line-driven and far less reliant on expense reduction. Throughout 2001-2002 (and early 2003), retailers supported earnings primarily by trimming their sourcing and operating costs as they rode out the long period of anemic growth in the top line.

Results for the important fiscal fourth quarter, which ended in January for most retailers, were still coming in at press time. But based on the results of the 32 major retailers that had reported by the end of February, it’s clear that the momentum that built up during the second and third quarters was sustained in the fourth (see table).

Net profits for these retailers rose 43 percent for the quarter versus the year-ago quarter and 26 percent for fiscal 2003 overall. Excluding Sears, which benefited from a large one-off gain on the sale of its credit and financial services business, net income for the remaining 31 names increased 21 percent for the quarter and 18 percent for 2003.

Perhaps the most telling statistic is that none of the 32 reported losses for either the quarter or the year. Only six, or 18 percent, reported lower profits than in the year-ago quarter, while seven, or 22 percent, did so for the year as a whole.

Three factors drove profitability: strong sales growth, improved merchandise margins resulting from superior inventory control and better demand fundamentals, and good expense control (despite a ramp-up of marketing costs by some retailers bent on strengthening holiday traffic).

Average same-store sales for this sample of retailers grew 4.3 percent for the quarter. (Only eight reported declining comp-store sales.)

These results continued the strong sales trends of the back-to-school/fall season and were a significant improvement over the period between early 2001 and early 2003. This sales-growth acceleration was made possible by a range of factors, including tax cuts, an improving stock market and low interest rates. Then, toward the end of the year, the job market appeared to be stirring; that helped boost consumer psychology, at least, if not spending power.

Top-line improvement came just in time, because many retailers are finding it hard to cut expenses much more. Having held the line for two years now, they feel intense pressure to increase spending, particularly for marketing. Marketing across all channels will grow in importance this year as retailers strive to ensure that consumers don’t miss the brand message.

Rising employee benefits costs, too, are straining the expense line.

Average operating expenses as a percentage of sales began rising slightly last year, but stronger sales trends in discretionary merchandise categories helped leading retailers in those categories expand gross margins. (These usually have two components: merchandise margins, and buying and occupancy costs. If sales grow faster than buying and occupancy costs, gross margins can increase even when merchandise margins do not.) Thus, more retailers in such categories as apparel and home goods enjoyed improved gross margins beginning in the third quarter. Year-on-year merchandise margins improved in the fourth quarter too, as retailers went into the holiday season with inventories matched to prevailing demand.

Particularly heartening is that this performance improvement needed little help from employment or real-wage growth. As these accelerate, the potential boost to consumer spending is substantial.

Also encouraging was the fragile recovery in the men’s market, first in business clothing and later in casual wear.

Most notable of all, however, was the well-documented improvement on the luxury side. Tiffany and Zale enjoyed substantial fourth-quarter income gains; so did upscale department store Nordstrom and specialty accessories retailer Coach.

The earnings data are a boost to shopping center owners, particularly those leasing space to retailers seeking the discretionary dollar. According to ICSC data, 31 retailers filed for Chapter 11 in 2003, up from 22 the year before. Also, some high-profile names either declared bankruptcy or admitted to being in financial difficulty after the holiday season. This is common, however, during the first quarter of any year, and it’s offset, at any rate, by the fact that most of the survivors have healthier balance sheets than they did a year ago. Cash and working capital on hand have increased on a year-over-year basis for the majority of chain-store retailers. Broad-based retailer profit growth and stronger balance sheets mean less risk of bankruptcy going forward.

But landlords should not get overly excited — stronger cash flow doesn’t guarantee increased deployment of capital for store expansion. Many retailers have reaffirmed their intention to focus on remodeling existing stores this year rather than open new ones. So even though the underlying viability of most retail chains is not an issue, maintaining shopping center occupancy rates will keep landlords’ shoulders to the wheel.

Michael Baker is a retail and economic consultant and former ICSC research director.

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