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Wall Street: Efficiency, Not Expansion

<CS:BOLD>NEW YORK -- Forget ROI. The retail acronym for 2002 is destined to be ROE.<BR><BR>Expansion still has its place, but it's ROE -- return on expansion -- that the financial community wants from retailers in 2002.<BR><BR>Stores have primed the...

NEW YORK — Forget ROI. The retail acronym for 2002 is destined to be ROE.

Expansion still has its place, but it’s ROE — return on expansion — that the financial community wants from retailers in 2002.

Stores have primed the expansion pump as a means to drive top-line growth and market share and combat the demons of deflation in the recent past. Now, with consumer demand for fashion faltering, margins dwindling amid an epidemic of discounting, and specialty store market leader Gap fighting an uphill battle to get its comparable-store sales and bottom line back into positive territory, Wall Street and other industry observers are looking to see stores boost their sales per square foot, realize a profit on their expansion to date and even reduce square footage when ROE isn’t possible.

Participants in a recent WWD Financial Forum also emphasized the need for greater responsiveness to consumer needs and the importance of better recruiting and training if stores are to become more in tune with their customers’ fashion and lifestyle requirements. Those attending were: Elizabeth M. Eveillard, senior managing director in the investment banking group of Bear Stearns; Dana L. Telsey, retail analyst at Bear Stearns; Gilbert W. Harrison, chairman of investment bank Financo Inc.; Abbey Doneger, president of retail buying office The Doneger Group., and Anne Maxfield, president of staffing resource firm Project Solvers.

The need to focus on store productivity was established early in the session by Telsey. “We have a rule of thumb that there are 400 good malls and 800 good strip centers,” she said. “We’ve seen that retailers’ same-store sales can decelerate after you’ve hit 400 malls. It’s our sense that basically the income level goes down as you go beyond 400.

“For 2002, the question will be how profitable are the stores that the retailers have. The key questions we keep asking retailers are: How are the stores that you’re opening this year doing versus last year? What are they generating in terms of year one? Are they doing better or worse? What do you see from these stores?”

The need for productivity was driven home yet again last Friday when Bear Stearns downgraded Gap’s stock to “attractive” from “buy” after Moody’s Investors Services and Standard & Poor’s, as reported, downgraded the retailer’s debt to junk status late Thursday.

“The bottom line is that [Gap] is a company in transition, but we believe that the various actions it has taken recently, such as its cash management, cost-cutting initiatives, head-count reduction, square-footage-growth slowdown and the separation of the Gap division into U.S. and International operations, should help to improve its financial position,” Telsey wrote in a research note.

Harrison noted, “We were talking with a company recently that opened 30 stores last year and 25 the year before, up from 10 the previous year. But the productivity in terms of sales per square foot was 50 percent below the stores that were open three, four or five years ago. The pressure to continually open stores is, at the same time, continuing to ruin these companies.”

Retailers, Telsey noted, have been very shy about closing stores. “Sometimes it is almost as if it could be an ego thing: ‘Look at how many stores I have compared to how many stores you have.’ We think that closing stores is certainly a positive. In terms of productivity, I don’t think we’ve ever had a year in which we’re going to see as many store closings in terms of square footage as we’re going to probably be seeing this year.”

While many retailers have closed stores or are in the process of determining which stores to close, the total square footage is not likely to decline. Harrison said that, at least until now, the real estate gets recycled, “unless it stinks. It is very rare that the real estate stays vacant. The number of square footage stays the same.”

That explains why retailers that aren’t even close to saturating the marketplace can move into areas that they’re not in yet, such as Kohl’s, Telsey noted.

“You may see a supermarket become a drugstore or some of these Kmarts becoming supermarkets,” Eveillard stated.

In addition to store closures, the panelists observed, retailers’ recent announcements indicate that they are also slowing the pace of new store openings compared with previous years.

“So perhaps by the end of 2002 and going into 2003, are we going to have a more profitable and productive retail landscape than what we have today? I think that’s more of a positive than a negative going forward,” Telsey said.

She added that Wall Street is more attuned to a “moderate same-store sales pace, maybe in the range of between 2 and 4 percent. A same-store gain is either a unit increase or a price increase. If you’re not getting price increases, it has to be more units coming through.”

Eveillard thinks we may be at the end of the cycle in which the industry whined about retailing being overstored but did nothing about it. “Companies that were pushing growth through indiscriminate store openings are not going to make it,” she said, “and we’ll see fewer companies doing that. Most of the companies that we’re talking to are focusing on store productivity and getting the sales per square foot up. They are also getting their costs down, not only at the top level but in the stores. In opening these stores, they are not settling for anything less than the appropriate returns on the investment.

“Wall Street is pitiless when it comes to the bottom line. It is up to the retailers to have that self-discipline. Don’t expect Wall Street to clap when you have self-discipline, but in the long run it will show in your numbers and [then] you’ll be rewarded,” Eveillard noted.

However, retailers can’t spell productivity without its first seven letters. “It all gets down to product at the end of the day,” she pointed out. “You’ve got to have the right product in the stores. Once you get that, all these other things can lead you to profitability.”

Whether because old clothes are wearing out or a new fashion protocol is emerging, such as a reversal of the casualization trend, the panelists said they expect fashion buying to resume soon. Especially in the aftermath of the events of Sept. 11, a bit more direction from the industry itself would help.

“The truth of the matter is everybody needs clothes,” Maxfield said. “So I think it is our job to make the clothes exciting, make them matter again and make people need to shop. We can do this by staffing businesses with creative talent, people who aren’t afraid to think outside of the box, whether they are retailers, manufacturers or designers.”

Telsey felt that getting the fashion content right was the greatest challenge for retailers, whether it be in their own assortments or those they purchase from their vendors. Merchants and designers “should go overseas, have focus groups, look at the styles, watch what people are wearing. On our shopping tours, whether it’s Minneapolis, San Francisco or Denver, people like to wear different things. One of the things we find so interesting when we talk to salespeople is that they’re really a retailer’s antenna on their customers. They’ve got really valuable information.”

Doneger added, “What the industry also needs is passionate, energetic leaders. We need merchants at the top. There is a difference in the way a financial person, without a merchandising and retail background, will operate a business. The timing and the understanding of the merchandising flow is key to doing well. It all comes down to having the right people and there needs to be an emphasis on recruiting talent to the industry.”

He noted that many of the best merchant-executives of years past came from retail training programs “that don’t exist anymore. When the talent exists, everything falls into place.”

Harrison recalled a conversation several years ago with a training-program veteran who’d matured into a well-respected industry veteran but complained that he couldn’t find talented people.

“He said to me, ‘I was told to go out into the market and buy goods. I learned by the mistakes that I made. Today everything’s done on the computers. The buyers are basically no more than processors.’ He explained that one can’t train a merchant that way. That was several years ago and it is even worse now,” Harrison said.

Doneger noted that much of the merchandise in stores doesn’t seem to be made with a particular customer in mind.

“That’s why specialty concepts seem to be working today,” he said. “Department stores are selecting merchandise with the business concepts or the financial issues in mind. In any business, we need newness. We need to execute from a merchandising point of view, not a financial point of view. It starts with understanding who is the targeted customer.” Telsey observed that Talbots Inc. has done a “great job [learning from] their customers through focus groups. They talk a lot and, frequently, the retailer is better able to target what their customers want.”

Another specialty chain earning high marks from the analyst was Limited Inc., whose Express and Victoria’s Secret chains are doing well. “The Limited has different concepts, each with very well-trained people who are very knowledgeable about the daily operations of their business. They even know how the units are supposed to sell in a day. This company does a good job training their sales people.”

A dramatic illustration of how the current market dynamic fails is in the prevalence of markdown money and chargebacks.

“Look at what markdowns are doing to these companies,” Harrison said. “It is killing them. The department stores especially, and many other stores as well, want apparel vendors to be their partner in losses, but they don’t want them to be their partner in profits. It’s a continuous cycle,” he said.

Telsey suggested that apparel firms could work with retailers on differentiating product from chain to chain.

“Department stores are great for convenience, assortment and selection under one roof,” she said. “Since there’s a limited number of apparel manufacturers, the issue is how do we get them and the department stores to work together in order to show differentiated product in some of the different chains.”

According to a Bear Stearns study on the apparel demographic landscape, the sector with growing apparel sales is the one targeting consumers age 55 and up. The study found that by 2005, that group will constitute 23 percent of the population mix. The other growing segments are the teens and college-age kids.

“Ten years ago, we had a lot of footwear stores. Now you have a lot of teen stores. Perhaps, five to 10 years from now, you’ll see more and more cater to this demographic segment. We think Chico’s and Talbots will perform well, along with Christopher & Banks. J. Jill is a developing company,” Telsey predicted.

One sector that will do well, although it has been hurt by consumer cautiousness and the downturn in tourism, is the luxury market. Even when soft, it supports lofty margins. “They get 65 percent plus gross margins because they are able to sell the goods at full price,” Telsey said. “The fact that luxury goods are now sold exclusively at directly owned stores gives them the ability to envelop the customers in their lifestyle.”

Those firms spend loftily on their stores and other components of their brand image, but doing so allows them to command higher prices.

“We are believers in luxury goods over time because the high net worth individual category is growing,” noted the analyst. “There are 7.2 million individuals worldwide with liquid net worth over $1 million. The luxury goods industry is an $80 billion industry that’s grown 6 percent on average over the past 10 years.”

So far, the retail and apparel industry appears to have started the year on a brighter note than one might have expected. While the challenge will still be how to get customers to pay full price, at least they’ve cleaned the inventory decks and are starting on a clean slate, Telsey noted.

Another priority, Harrison noted, is that retailers have to wean themselves off of off-price selling.

Sounding a note of caution, Maxfield said, “So far it seems that every time we start to get optimistic about the economy, especially in apparel and retail, we sort of get another body blow. First it was Sept. 11 and then Kmart filing for bankruptcy. The good news is that the industry is a resilient one.”