NEW YORK — At least in one sense, the fourth quarter went according to plan for retailers.
While the most upbeat hopes for a quarter filled with sales increases failed to materialize, the "plan" was for lean inventories to help salvage the fourth quarter, minimizing margin risk as consumers displayed a penchant for penny-pinching in a tough economic climate.
The final sales results for the quarter were tallied last week, with retailers noting that strong sales of clearance goods drove generally lackluster results. But low inventory levels at many companies allowed them to sustain margins throughout the three months, allowing several — including Gap, Wal-Mart, J.C. Penney Co. and even Ann Taylor, which had double-digit same-store sales declines in both December and January — to raise fourth-quarter guidance.
Promotions and ample amounts of wintry weather helped stores hold the line on sales through Christmas, leaving them with cleaner-than-expected inventory positions in January. This "shrink to fit" approach, as one analyst called it, resulted in fewer markdowns, thus higher overall profits. Stores on the February-through-January retail calendar begin reporting earnings for the year’s final quarter this week, with The May Department Stores Co. — down 4.4 percent in January on a comparable-store basis — leading off on Thursday.
Most striking among last Thursday’s comp results was Gap’s 16 percent overall same-store sales improvement, reversing last January’s 16 percent decline. Gap’s report reflected an improvement in the average ticket due to less steep markdowns versus last year’s, more units per transaction and an improved conversion rate on slower traffic. Inventories ended the month, quarter and the year slightly higher than the original plan of positive high-single-digit growth on a per-square-foot basis because of the early receipt of spring merchandise, the company said.
As a result of the better-than-expected results, as well as the anticipated benefits of a lower effective tax rate, Gap said it anticipated fourth-quarter earnings in the range of 23 to 29 cents and full-year earnings to be between 51 and 57 cents. The benefit of this reduced tax rate is 4 to 7 cents to fourth-quarter earnings. Without the benefit of the tax rate, the guidance is 19 to 22 cents compared with a loss of 4 cents last year."Positive customer response to holiday product assortments across all brands helped drive momentum in the month and enabled us to clear merchandise at better markdown margins," Sabrina Simmons, treasurer, said on a prerecorded conference call last Thursday.
Other than Gap, perhaps the biggest surprise about January comps was Wet Seal’s 25.1 percent decline, followed by the dismissal of longtime chief executive officer Kathy Bronstein.
Abercrombie & Fitch and Aeropostale also raised fourth-quarter earnings estimates based on lower promotional activity. A&F said it now expects to exceed its previous earnings-per-share guidance for the fourth quarter of 86 to 88. Aeropostale said it now anticipates earnings between 44 and 46 a share versus its prior guidance of 38 to 40 cents.
After digesting January’s results, and particularly gross margin improvements, Steve Skinner, a partner at Accenture’s retail industry group, said he took on a more upbeat outlook.
Noting January was "marginally positive," Skinner said, "companies that had good results in December, like Penney’s, may at first look like they had bad results in January, but they had less merchandise to move last month."
Penney’s department store comps fell 3.8 percent in January, and were below plan due to lower levels of end-of-the-season clearance merchandise after a 4.7 percent spike in December. The company said EPS for the fourth quarter are expected to reach at least 65 cents a share.
Also, Wal-Mart in January reported relatively modest results, comping up 2.6 percent, at the lower end of its guidance and less than its 3.3 percent increase in December. Still, the world’s 800-pound retailing gorilla upped its full-year guidance to $1.80 from $1.78.
"Retailers that are relatively operationally efficient see that it equates to improved profitability," Skinner said. "I am encouraged the way January turned out."
Dana Telsey, retail analyst at Bear, Stearns, said: "Sales levels in January revealed retailers can beat some of their fourth-quarter guidance because the level of markdown goods sold was not as deep as last year. Margins were better. Even in the face of weaker top-line growth, retailers were still able to generate traffic."
Highlighting Telsey’s point, Ann Taylor, despite its 10.3 percent comp drop, said it enjoyed nice gross margin expansion as inventories were down 9 percent per square foot at the end of January, following a 15 percent decrease in December. Despite the rough sales month, AT raised guidance for the fourth quarter to 34 to 35 cents from 32 to 33 cents, based on the margin expansion. Chairman J. Patrick Spainhour said in a statement: "Our ability to deliver these results despite a continuing soft retail environment reflects excellent controls on operations and costs, inventory management and our success selling more product at or near full price."Telsey noted that most retailers brought inventories down in the mid-single-digit range compared with last year, allowing them to sell merchandise at the first markdown, which is usually at a 20 to 30 percent discount compared with last year, when retailers sometimes took up to three markdowns, reducing prices 60 percent.
As a result of the better margins and leaner inventories, the analyst said she raised the fourth-quarter earnings outlook for Ann Taylor, Limited Brands, Talbots, Gap and Abercrombie & Fitch.
However, Dana Eisman Cohen, a retail analyst at Banc of America Securities, pointed out that while retailers have indeed raised guidance, plans and expectations were reduced throughout the quarter. "People took down expectations as soon as Christmas did not play out," she said.
While tight expense and inventory control might help bail out the fourth quarter for several retailers, some observers say stores may have squeezed just about all the excess out of these areas and are unlikely to be able to build earnings with little or no sales growth in the future.
Todd Slater, a retail analyst with Lazard Frères, wrote in research notes that retailers generated robust earnings growth in the first half of 2002, as low inventory levels resulted in a big upside in gross margins. The 28 retailers in Standard & Poor’s Retail Index saw their "earnings grew 27.3 percent through the first three quarters of 2003 versus a 4 percent increase for companies in the S&P 500," he said. "Without even reaching a conclusion as to how the consumer will shape up in 2002, retailers have extremely challenging comparison coming out of the starting gate compared to the rest of the market."
However, for the second half of 2003, Slater noted top-line growth should get a boost due to a more favorable holiday calendar and a stimulus package coming out of Congress, enabling retailers to better leverage cost-cutting initiatives undertaken in 2002.
A.G. Edwards & Sons Inc. analyst Robert Buchanan cast doubt on those who blame a lack of fashion innovation for recent sluggish sales.
"You could bring out some great newness today, but I’m not sure that it would work," he said. "You need the newness, but you also need the proclivity to spend."
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