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More Pressure on Profits in ’94

NEW YORK -- Most discounters should have a better year in 1994 than they had in 1993, but an increasingly crowded market will continue to pressure profit margins, Wall Street analysts say.<BR><BR>Greater competition due to store expansions -- as well...

NEW YORK — Most discounters should have a better year in 1994 than they had in 1993, but an increasingly crowded market will continue to pressure profit margins, Wall Street analysts say.

Greater competition due to store expansions — as well as weak demand for apparel — dented the bottom lines of most discounters in 1993 and drove Jamesway Corp. and Rose’s Stores into Chapter 11 proceedings.

Discounters also suffered a slowdown in the rapid sales growth they had been enjoying over the past few years. Even Wal-Mart Stores, the undisputed discount champ, saw sales soften at its discount units in 1993, although bottom-line profits continued to be strong.

Over the past five years, however, discounters have raked in gains of 10 percent, compared with 2 percent for department stores.

Looking to 1994, Wall Street analysts said an improved economy and a pickup in demand for apparel should revive the bottom line for discounters. Some analysts are skeptical about whether the economy would perk up sufficiently. What seems certain, analysts said, is that the discount industry will remain fiercely competitive as the big three — Wal-Mart, Kmart and Target — as well as many regional chains, continue with aggressive store expansion programs.

Wal-Mart plans to add 115 stores in 1994 by penetrating further into the Northeast, Alaska and Hawaii. Kmart will add 140 to 150 new units under its new discount store evaluation program, either by opening new stores in new markets or replacing stores in existing markets.

Target, the discount division of Dayton Hudson Corp., expects to add 50 to 60 stores.

Among the regional chains, Caldor Corp. plans to open 13 to 16 stores in 1994; Venture Stores plans about 10 stores; Bradlees expects to open four to six stores, and Shopko looks for five to 10.

Kimberly K. Walin, retail analyst at Lehman Bros., said she expects most discounters in 1994 to see “a pretty aggressive pricing environment, especially until we see some better demand in the apparel business.”

Walin said discounters’ margins were under pressure last year because hard goods such as appliances and domestics have been outperforming apparel and other soft goods. Apparel typically has higher margins than hard goods.

George Strachan, an analyst at Goldman Sachs, said he also sees pricing pressures continuing in the industry. “There may be some attempt to gain back some margin after 1993, but my suspicion is that Wal-Mart — being the pricing umbrella for the industry — is not going to allow anybody else to gain ground,” he said.

Strachan said the consumer is “under significant pressure” because real wages — wages adjusted after inflation — have remained stagnant for the last decade and much of the recent increase in consumer spending was funded on credit.

He said the first half of 1994 should show some improvement in apparel for discounters if weather patterns are normal, because weather last year was exceptionally cold and wet.

Daniel Barry, an analyst at Merrill Lynch, was more optimistic, sees discounters having a “very good year.” He said, “We expect them to benefit from a strong economy, and hopefully, we’ll see a little better fashion trend. Barry said the economy has strengthened over the last couple of months, and he looks for the employment rate to improve as well.

Michael Exstein, retail analyst at Kidder Peabody, said he expects discount stores to do “reasonably well” in 1994, but said, “There will certainly be much more growth in square footage in 1994 than there will be in demand.”

Exstein also said discounters may have to respond to lower pricing strategies at department stores, which helped the department store to show apparel gains during Christmas at the expense of discounters.

“Discounters may have to operate differently next year than they have in the last two or three years because the pricing gap between themselves and other channels of distribution has narrowed,” he said. The big surprise, Exstein said, has been the staying power of the regional chains, which “about 18 months ago were headed for extinction” as Wal-Mart mapped its expansion path across the U.S.

“The regional discounters have been able to carve a regionally segmented niche in the business, and they are now starting to expand once again,” he said.

Strachan, however, said many of the regional chains will still find it tough competing against the big national chains, which in general are better capitalized and have lower cost structures.

He said many regional discount chains are attempting to “remerchandise themselves” around Wal-Mart by becoming more fashion-oriented stores.

“For the regionals to succeed, they have to be able to respond better to fashion trends and, at the same time, be able to respond to regional pricing and regional tastes,” he added.

Barry expects Wal-Mart Stores to net $1.04 this year against 84 cents, and looks for profits to increase to $1.25 in 1994.

“They’re still arguably the best retailer in the country,” he said. Barry said Wal-Mart should be helped by rapidly expanding its core discount stores, the aggressive rollout of its supercenters, expansion into Mexico and improved sales at Sam’s Club.

Exstein expects Kmart to earn $1.70 a share this year, down from $2.40 in 1992. For 1994, he looks for $2.10 a share. Exstein said Kmart decided to exit the warehouse club business and has agreed to sell its Payless Drug Stores Northwest subsidiary to concentrate on reviving its underperforming discount chain and its other specialty store businesses.

Stronger fashion trends should help stores such as Target and Caldor, which are more upscale than Wal-Mart and Kmart, Exstein said, adding that Target’s upscale presentation is being well received.

Exstein expects Caldor to earn $2.50 in 1993, slightly down from $2.54 in 1992, but looks for earnings to bounce back to $3.20 this year.

Edward F. Johnson of Johnson Redbook said Bradlees has been hurt by a “very competitive” selling climate in the Northeast, where most of its stores are. “They’re fighting to survive,” Johnson remarked. He expects Bradlees to earn $1.44 in 1993, down from $2.16 from continuing operations last year. He looks for Bradlees to net $2 this year.

Johnson said Venture’s sales picked up in the third quarter and momentum has continued in the fourth quarter. He expects Venture to make $2.45 in 1993 against $2.82 from continuing operations the year before. In 1994, he projects $2.75.