By  on April 9, 2007

Better-managed markdowns, stronger same-store sales and improved inventory management boosted gross margin rates for most retailers during the fourth quarter of 2006.

Of the companies that released fourth-quarter results, 24 delivered higher year-over-year gross margin rates, while 17 posted declines and one retailer was flat. The average year-over-year gain was 34 basis points.

The top margin increases were from Gymboree, Stage Stores and Saks Fifth Avenue, where gross margins gained 571, 497 and 431 basis points, respectively. Aéropostale, Guess and Neiman Marcus also showed significant margin gains with respective increases of 371, 347 and 322 basis points.

Other notable gains were made by Hot Topic, 186 basis points, and J.C. Penney, 183 points. It's important to note that 14 of the gainers posted gross margin increases of over 100 basis points.

On the declining side were retailers Pacific Sunwear, Ann Taylor and Bebe, which posted decreases of 482, 340 and 277 basis points, respectively.

The higher, year-over-year gains were achieved even though retailers initially struggled to get holiday shoppers through their doors. Analysts said better inventory management, planned and more disciplined markdowns and robust gift card sales bolstered results. Comps also played a role.

Margaret Mager, equity analyst at Goldman Sachs, said, "Strong gross margins can be driven by positive same-store sales, which create leverage of fixed costs."

Mager said some of the top margin gainers were "turnaround stories after suffering from fashion missteps and lower gross margins in the year prior: Aéropostale, Gymboree, Hot Topic."

The fashion missteps "caused excessive markdowns" in the prior year, she said, which made the year-over-year comparison easier to beat. "When retailers change the level of markdowns year-over-year, as they improve their merchandise selection, this can also help boost gross margins," Mager added.

In the high-end sector, the analyst said it was likely the retailers "increased the margins of their product lines like accessories and handbags."

More favorable sourcing costs can bolster margins, said analysts, who added that technology was also helping drive up gross margins.

In a research note earlier this month, Dorothy Lakner, equity analyst at CIBC World Markets, cited technology as one reason for American Eagle's 157 basis point gross margin gain. "Investments in technology are helping American Eagle put more of the right inventory in the right stores and sell more of it at full price, eliminating the coupons of the past," Lakner said. "Markdown optimization and size profiling are helping margins already, and further system improvements, such as demand forecasting, are in the wings, with further improvements to show up in 2008."At Gymboree, the robust gross margin gain was a reflection of its sourcing, Lakner said. "Despite the big gains from sourcing in gross margin in 2006, Gymboree still has room to go on the sourcing side of the business, and although benefits are likely to moderate from the 'big bang' we saw in 2006, they should equate to 100 basis points in merchandise margin gains each quarter in 2007," the analyst said. "The focus in 2007 is on continuing to develop relationships with new factories and new countries — moving away from China, which is getting expensive, into South Korea and South Korean-owned factories in Guatemala that provide quality product at a lower cost, or Chinese factories in India."

Stanley Officina, president of Ultimate Financial Solutions, said many bigger retailers were bolstering margins via chargeback and markdown allowances. "Retailers are sacrificing margins on the selling floor and making up for it by going back to their suppliers with allowances," he said. "They make up their margins by bringing down the cost of goods by leaning on their suppliers."

Officina described markdown allowances and chargebacks as a "slow-growing tumor" in the industry. Due to pressures from Wall Street, Officina said big retailers were focused on "profit centers" such as chargebacks. "To some degree, they stop being merchants and start being bean counters," he added.

FAT MARGINS
YEAR-OVER-YEAR GROSS MARGIN RATES FOR 4TH QTR. 2006 (SHOWN AS A PERCENT OF SALES)
RETAILER4th qtr. '06 4th qtr. '06 Amount Change
Gymboree48.6042.895.71
Stage Stores32.1527.184.97
Saks Fifth Ave. Enterprises37.8933.584.31
Aeropostale37.2433.533.71
Guess46.0342.563.47
Neiman Marcus34.3931.173.22
Hot Topic33.9532.091.86
J.C. Penney38.0435.211.83
New York & company33.3731.761.61
American Eagle47.9246.351.57
Mother Work51.8950.321.57
Buckle 43.19 41.92 1.27
Zumiez39.38 38.12 1.26
Bont-Ton38.2737.261.01
Nordstrom38.2637.460.80
Cache48.2547.590.66
Ross Stores23.4822.880.60
Walgreens28.9628.440.52
Wal-Mart (discount stores)22.9622.660.30
Citi Trends38.3938.130.26
Target32.2732.090.18
Stein Mart29.3929.290.10
Dress Barn37.9237.860.06
Federated 40.9440.880.06
Wet Seal33.6133.610.00
TJX Cos.23.0423.11-0.07
Abercrombie & Fitch66.3566.51-0.16
Costco12.3112.48-0.17
Kohl's35.3235.54-0.22
Dillard's34.4434.75-0.31
Rite Aid26.7127.06-0.35
Chico's FAS58.7359.39-0.66
Limited Brands (total apparel)40.0640.76-0.70
Gottchalks33.1333.85-0.72
Cato30.8131.87-1.06
Deb Shops43.0844.16-1.08
BJ's Wholesale Club10.6211.74-1.12
Gap (U.S. stores)32.5234.04-1.52
Bebe47.9450.71-2.77
AnnTaylor 47.5950.99-3.40
Pacific Sunwear31.5036.32-4.82
Wilsons37.5944.88-7.29
Average:36.8736.520.34

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