Volume-Generating Sales Promotions Will Hurt Q4 Earnings

Discounts cut into margins, forcing many retailers to lower guidances.

The promotions that helped produce last-minute holiday sales might have lightened many retailers’ inventories, but the bite they took out of profit margins will come back to haunt them next month when they begin to tally their fourth-quarter and year-end earnings.

This story first appeared in the January 12, 2009 issue of WWD.  Subscribe Today.

Discounts were so deep that, while they helped to generate individual purchases, they offered only limited relief to overall revenues, several analysts noted. Whereas December comparable-store sales weren’t quite as bad as some had feared, the promotions that aided the generation of those numbers are likely to come back to haunt stores as they calculate their bottom lines.

They’ve also set the tone for a challenging first quarter, when consumers won’t have the imperative of gift-giving to get them to the stores.

Many comp reports last week were accompanied with warnings of lower profits.

“The final two weeks of the month prevented a catastrophe but were not enough to forestall the completion of the worst holiday season in recent history,” said Brean Murray Carret & Co. retail analyst Eric Beder.

Beder said the “key shock” to investors was the “highly significant decline in margins as retailers pulled out all the stops.”

Lazard Capital Markets retail analyst Todd Slater said comps might have turned out slightly better than estimates, but because margins were savaged, it was a “Pyrrhic victory at best.”

Pali Capital retail analyst Amy Wilcox Noblin called the weeks leading up to Christmas “staggering,” adding that comp results “portend for a very weak spring season.”

Lowered guidance from Wal-Mart Stores Inc. set the tone after the discounter missed analysts’ expectations of a 2.8 percent comp increase in its U.S. stores, excluding fuel, and instead posted a 1.7 percent rise. The world’s largest retailer reduced its fourth-quarter earnings guidance for continuing operations to a range of 91 cents to 94 cents a share, down from its earlier projection of $1.03 to $1.07.

Mall-based teen retailers Abercrombie & Fitch Co., American Eagle Outfitters Inc. and Pacific Sunwear of California Inc. all reevaluated their earnings outlooks after posting comps that slumped 24, 17 and 10 percent, respectively.

Abercrombie said that as a result of a $10 million tax expense related to the new employment agreement of its chairman and chief executive officer, Michael Jeffries, the company anticipates that earnings per share next quarter will be “significantly below” its previously issued guidance of $1 to $1.05 a share.

American Eagle said that, while post-holiday inventories are on target, it expects fourth-quarter earnings in a range of 19 cents to 21 cents a share, down from previous guidance of 30 cents to 36 cents a share. PacSun said it expects to report a fourth-quarter loss of 38 cents to 43 cents a diluted share, including an estimated gain of about 10 cents a share from the sale of its Anaheim, Calif., distribution center. The company said 19 cents of the loss was attributable to “markdown reserves.”

Erin Armendinger, managing director of the Jay Baker Retailing Initiative at the Wharton School of the University of Pennsylvania, said that post-holiday, retailers face a dearth of selling opportunities. Because spring inventory was ordered before the full fury of the financial crisis hit, retailers must scramble to clear out excess holiday items, while attempting to sell a larger-than-necessary shipment of new merchandise.

“It’s the perfect storm for retailers — but in a bad way,” said Armendinger. “Spring is going to be messy.”

Caché Inc., which reported a 19 percent comp decline, said it revised its guidance to a loss of 48 cents to 50 cents, including costs related to store closures and management changes totaling 21 cents a share. Not including these costs, the company expects a loss of 27 cents to 29 cents a share. This compares with previous estimates of EPS at the low end of its previous guidance range of 24 cents to 29 cents.

According to Sterne, Agee & Leach retail analyst Margaret Whitfield, Caché will “lose money” in the near term, as it plans to cut between 30 and 35 percent of its inventory per store.

The “danger” in too much stock reduction is “overreacting,” Whitfield said, adding that retailers must give consumers a reason to shop.

Still, Whitfield said Caché’s inventory slashing will put the retailer in a good position should the economy get worse.

Some of the most surprising downward revisions and words of caution came from retailers that don’t report comps on a monthly basis.

After comps fell 13 percent during the firm’s second quarter, Coach Inc. revised its earnings for the period to between 67 cents and 69 cents a share on sales of $960 million, down from its previous outlook of 77 cents a share on sales of $1.05 billion. The news, released after the markets closed on Thursday, contributed to a $2.79, or 13.4 percent, decline in Coach’s stock price on Friday, to $18.11.

“Weakness is systematic of the retail environment, not Coach’s operations,” said Lazard’s Slater, who tinkered with his estimates of the vendor’s stock.

Job cuts also followed EPS reductions, as Macy’s Inc., which reported a 4 percent comp decline, said it would close 11 underperforming department stores. The retailer said it expected earnings in a 90 cent to $1 range, down from $1.10 to $1.30.

But according to Matthew Katz, managing director at Alix Partners LLC, earnings revisions, job cuts and store closures are not surprising.

“Management teams have been reacting to the economy for months,” he said. “All retailers can do now,” he said, “is control what you can control and preserve liquidity and cash availability.”