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Fiscal Woes Darken Holiday Outlook

Markets rally on government plan, but prospects trouble analysts.

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Capping a week of stunning economic developments, the federal government’s financial rescue plan gave analysts a chance to reconsider the fourth-quarter retail outlook — and most took a fairly dim view.

The breakneck pace of developments — the government’s decision to purchase distressed mortgages, temporarily banning short selling of certain stocks and strengthening money-market funds with an infusion of billions of dollars — were indicative of the dire circumstances as the credit market all but collapsed.

Although the moves pumped up stock markets around the world on Friday, analysts said the longer term is fraught with difficult challenges and uncertainty.

“Generally speaking, the reaction in the financial markets is amplifying an underlying fear among consumers,” said Richard Hastings, consumer strategist at Global Hunter Securities LLC. “I would expect that, despite some relief in the immediate term in the financial markets, the damage to consumer confidence will probably start to show up in various things including readings of consumer sentiment and their buying intentions over the next four to six weeks. With the effects of Hurricane Ike, gas price increases and the financial markets in chaos, the holiday season will be unusually weak.”

Indicative of the mood was the extra scrutiny given to high-flying Aéropostale Inc. Goldman Sachs & Co. retail analyst Michelle Tan downgraded the stock to “neutral” from “buy.”

“School openings are behind us, suggesting teens have less need to shop from here,” Tan wrote in a research note, adding that low clearance activity at the teen retailer would drag sales in coming months.

Increasingly sluggish mall traffic will contribute to a slowdown in sales, she said.

However, despite limited traffic, Tan upgraded Gap Inc. to “buy” from “neutral,” partly because of a new dynamic merchandise assortment for the holiday season. The nation’s largest specialty apparel chain also won high marks for controlling its inventories and expenses.

“We’re probably at the start of a multiyear price war,” said Jeffries & Company Inc. retail analyst Randal Konik, who added that he hasn’t seen such an emphasis on low pricing since discount titan Wal-Mart Stores Inc. exploded on the retail scene.

Konik on Friday initiated coverage on teen retailers Aéropostale Inc., American Eagle Outfitters Inc. and Abercrombie & Fitch Co. with respective ratings of “hold,” “buy” and “underperform.”

He said although Aéropostale is the “value price leader in teen retail,” the stock’s valuation, with shares up over 40 percent year-to-date, is “not compelling.”

As for American Eagle, he said “after a tough stretch of down productivity and profitability” recent initiatives to “reinvigorate the business” have made the stock more attractive. The Pittsburgh-based retailer has been working on strengthening its “value pricing message,” as well as tightening inventory and putting out a “bolder” product assortment, Konik said.

Abercrombie & Fitch has “held up fairly well until now,” Konik said, but “sales and margins are at risk. Management focus is currently very long-term oriented with aggressive international openings, brand protection and other investments. Meanwhile, negative [comparable-store sales] trends are getting worse with a lack of positive catalysts.”

With the tough economic conditions, “it’s like trench warfare out there, and rivals are reacting with price,” Konik said, adding that Abercrombie may have to “at least reconsider” its strategy of maintaining high prices in order to protect its brand and margins.

He predicted that retailers, in general, will be going through a “down cycle of operating margins,” as prices are lowered to remain competitive and transportation and manufacturing costs rise. Growing unemployment, high energy prices and tightening credit are just a few of the “most influential” factors impacting consumer spending.

Raymond James retail analyst Samantha Panella agreed, but added that “there are still some retailers bucking the trend.”

Among them is Urban Outfitters Inc., which has been managing cost and inventories, she said. Second- quarter earnings for the specialty retailer surged 78.8 percent and the company’s e-commerce business is strong. Direct sales, which comprise catalogue and Internet, jumped 42 percent to more than $60 million for the quarter, with a circulation increase of just 8 percent.

Panella said Urban’s relatively low store count is a plus given current conditions. Even though the retailer, which operates 132 Urban Outfitters stores, 115 Anthropologie stores, 21 Free People stores and one Terrain garden center, said it plans to open 45 new units during the fiscal year it doesn’t run the risk of “cannibalizing its business,” she said.

Looking to the holiday season, RBC Capital Markets Corp. analyst Howard Tubin said retailers that offer “something exciting” would fare well. New merchandise and lean inventories will still be the name of the game, he said, as retailers duke it out to get customers buying as early as possible.

Limited Brands Inc. is well-positioned going into Christmas, Tubin said, with brands Victoria’s Secret and Bed, Bath & Body Works set to launch several new products.

Nonetheless, he expects holiday shopping to start late.

“I’m not looking for it to be a great holiday season,” Tubin said. “Consumers shop when they need to shop.”

Despite the long-term questions, the stock market came roaring back Friday. The 3.87 point gain in the Standard & Poor’s Retail Index left the measure at 394.24, just 3 percent below its level of a week ago and 5.5 percent above its close last Wednesday, when stocks sustained their biggest losses since the aftermath of the Sept. 11, 2001, terrorist attacks. The Dow Jones Industrial Average rose 368.75 points, or 3.4 percent, to close at 11,388.44, down just 0.3 percent for the week and 7.3 percent higher than on what some are calling “Black Wednesday.”

Aéropostale and another recent strong performer, Buckle Inc., were among the few specialty store stocks left behind on Friday’s rally, their shares declining 4 percent and 1.7 percent, respectively. A&F dropped 0.1 percent, but Pacific Sunwear of California Inc. rose 21.9 percent, American Apparel Inc. 13.9 percent, Zale Corp. 9.7 percent and American Eagle 1.8 percent. Although department stores handed in mixed performances, The Bon-Ton Stores Inc. and Dillard’s Inc. excelled with increases of 13 percent and 9.5 percent, respectively.

However, discounters didn’t fare well. Wal-Mart Stores was off 2.9 percent, Target Corp. down 4 percent and off-pricer The TJX Cos. Inc. 1.2 percent lower.

Sears Holdings Corp. dropped 1.5 percent after a downgrade on about $3.6 billion of its debt to “B+” from “BB” based on weak sales and strategy. The company responded that it was being “unfairly treated” based on its reduced debt levels, “demonstrated history of cash flow generation and available assets.”

In Tokyo, the Nikkei 225 ended the week on the upswing with a 3.8 percent rise to 11,920.86. Among the fashion-related companies joining in the rally were department store operator Isetan Mitsukoshi, up 2.1 percent, apparel producer Onward Holdings, up 4.6 percent, and Mitsubishi Rayon Co. Ltd., up 7.5 percent.

In London on Friday, the FTSE 100 surged 8.8 percent to 5,311.30, breaking a four-day losing streak for the index. Burberry Group plc jumped 7.8 percent, Marks & Spencer Group plc gained 5.5 percent and French Connection rose 3.6 percent.

Taking part in the general ascent from elsewhere in Europe were: Hermès (11.5 percent), Inditex Group (9.3 percent), Hennes & Mauritz (up 8.1 percent), PPR (7.4 percent), Tod’s (7.3 percent) and the Swatch Group Ltd. (6.7 percent).

President Bush, flanked by Fed chairman Ben Bernanke and Treasury Secretary Henry J. Paulson Jr., said at the White House Friday that the government “must act now to protect our nation’s economic health from serious risk” because of deteriorating confidence that had effectively halted financial transactions such as loans to businesses and consumers.

Now, Congress and the White House will work on legislation to give new powers to the administration, expanding the “toolbox” the government has to address the crisis so it can purchase bad assets such as distressed mortgages from banks and institutions. Estimates of the cost make it the most expensive program in U.S. history and Congress is scheduled to adjourn at the end of next week.

“Our system of free enterprise rests on the conviction that the federal government should interfere in the marketplace only when necessary,” Bush said. “Given the precarious state of today’s financial markets and their vital importance to the daily lives of the American people, government intervention is not only warranted, it is essential.”

The hope is removing the assets dragging on firms will improve individual markets and eventually restore confidence in the financial system. The administration and Paulson have been adamant that the current financial crisis stems from problems rooted in the mortgage market.

Paulson made the rounds of political shows on Sunday to stress the urgency of Congress passing a proposed $700 billion bailout emergency package that will give both he and Bernanke expanded authority to shore up the nation’s faltering financial institutions. Several key Democrats in Congress said Sunday they would work quickly to pass the package this week but they said there would be some additions to the legislation to help protect taxpayers and homeowners.

The Bush administration released details of the proposed legislation Saturday and continued to work through the weekend with legislators to clinch a final emergency package to purchase troubled residential and commercial mortgage-related assets.

“The markets are fragile. We have a serious situation,” said Paulson on “Fox New Sunday,” a message he reiterated in appearances on NBC, ABC and CBS. “Last week, the credit markets were frozen and clogged up. For a while there, American companies, industrial companies, weren’t able to raise financing. If we get to a situation where companies can’t readily raise finances, where it’s typical for farmers and small businesses to get loans, where people’s retirement incomes are threatened — that’s a situation we don’t want to have and that’s why it’s very important we move quickly and stabilize the markets by buying these illiquid mortgage loans from the financial institutions, which are clogging up the system.”

Paulson emphasized the need for speed and a “clean” bill, free of add-ons by Congress, but Democrats said Sunday they planned to add necessary protections for taxpayers and help thousands of homeowners, facing foreclosure, keep their homes.

“What we’re talking about is not just happening to Wall Street,” said Sen. Christopher Dodd (D.,Conn.), chairman of the Senate Banking Committee, on ABC’s “This week with George Stephanopoulos.”

“It is what is happening to main street-retirement accounts, 401Ks, pension funds, student loans and credit cards. Credit card debt is being securitized. What will it do to people’s ability to finance their needs on a daily basis? All of these are the ripple effects,” Dodd said.

Sen. Charles Schumer (D-N.Y.),the chairman of Congress’ Joint Economic Committee, said on the Fox show that he also believed changes to Paulson’s plan were necessary, including the creation of a government oversight board.

Schumer also indicated that House and Senate leaders were considering moving a separate economic stimulus package “alongside” the emergency bailout legislation “but not part of it.”

Democratic leaders had recently said a stimulus package would have to wait until the financial rescue legislation was passed.

Leaders have been considering billions of dollars in infrastructure funding to help create new highway and construction jobs, a new round of unemployment insurance extensions and a bailout for the U.S. automobile industry.

“Many believe we need a stimulus package,” said Schumer. “Many of us believe this is an appropriate time to do it before Congress adjourns. We can’t wait.”

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