As executives in the department store sector put the finishing touches on their first-quarter earnings reports — released beginning today — analysts are noting clear challenges ahead.
The first quarter may be the least important one for stores, but when a retailer is still jittery because of inventory issues from last year’s fourth quarter while sitting on in-season items that just don’t seem to be selling, there is cause for concern, according to several recent analysts’ reports.
Looking over the longer term, department stores across the globe have seen tangible progress in regard to inventory management. An analysis of key metrics over the past four years reveals that initiatives by department store retailers to reduce costs and boost gross margins have been a success. Those gains are viewed as essential in light of the severe erosion in profit and return margins during the same period. One of the factors eroding profits is the online push for market share, which according to a recent HRC Advisory report is eating away at pre-tax profits by 25 percent.
On the positive front, according to data from S&P Capital IQ, the selling, general and administrative costs as a percent of sales fell from an average of 11 percent in 2012 to 9.5 percent today. Gross margin rates have increased 190 basis points to 36.8 percent today from 34.9 percent four years ago.
The drop in SG&A margins reflects an industry mantra touting the importance of stringent and ongoing cost controls. The industry average gain in gross margins is indicative of recovery since the Great Recession, when retailers engaged in markdown mania. From here, it is unclear whether gross margins will hold steady given last quarter’s dismal holiday shopping season as well as consumers’ ongoing love affair with having experiences over buying “things.” And from a bottom-line perspective, profits have evaporated.
In the same four-year period that gross margins gained and SG&A declined, profit and return margins have steeply declined. Net income as a percent of sales fell to an average of 2 percent today from 5.2 percent in 2012, according to S&P Capital IQ’s data. And earnings from continuing operations as a percent of sales dropped to 2.2 percent from 5.6 percent in that same time period.
Weaker net income margins also translate to diminished equity returns. The average return on equity — the amount of net income returned as a percentage of shareholders’ equity — for the department store sector dropped to 7.4 percent today from 10.3 percent in 2012.
In the same period, the return on assets, which indicates the profitability of a company relative to its total assets, dropped to 3.2 percent today from 3.7 percent four years ago. Return on capital — a measure of how a company leverages its money to create returns — also declined, falling to 4.9 percent today from 5.9 percent four years ago.
For the upcoming first-quarter earnings season, analysts are concerned over stiff headwinds in the department store sector. Macy’s Inc. reports today. Kohl’s Corp. and Nordstrom Inc. report results on Thursday, while J.C. Penney and Co. releases results on Friday.
Last week, Analysts at Telsey Advisory Group cut earnings and same-store sales estimates on the department stores the firm tracks. The revisions are amid a “growing gap” between total inventory and sales at the end of the fourth quarter of 2015 coupled with a challenging retail environment. The equities research firm said that the “main focus of the [first quarter] earnings season will be the result of the purging of inventory and at what expense to margins.”
The report follows a similar outlook by RBC Capital Markets analyst Brian Tunick last week. The scenario centers on department stores that are making heavy investments in e-commerce as well as rolling out off-price concepts to thwart the onslaught of companies such as TJX Cos. Inc., Ross Stores Inc. and Burlington Coat Factory. Tunick also noted weaker margins in the sector due to steep markdowns, which he expects to continue. The analyst also has concerns over the strength of department store balance sheets.
In the department store sector report, Dana Telsey, chief executive officer of Telsey Advisory Group, said she expects these retailers to reveal “another choppy [first] quarter given volatile weather, discernible consumer buying behavior that includes a wear-now mentality and weak tourism.”
The firm revised its same-store sales estimates and is forecasting an average comparable-store sales decline of 1 percent, which compares to consensus estimates of a 0.6 percent decline. Telsey Advisory Group expects Dillard’s Inc. to post a quarterly comps decline of 2 percent, which compares to the firm’s prior estimate of a 1 percent decrease. Telsey also revised the quarterly estimate of Macy’s Inc. from a decline of 3.5 percent to a drop of 3.8 percent.
Similar downward revisions to comps as well as quarterly earnings were done for Kohl’s Corp., Nordstrom Inc. and Stage Stores. Telsey kept J.C. Penney Co. in line with consensus estimates, which calls for a 3.8 percent same-store sales gain. J.C. Penney and Kohl’s were the only two in the sector that Telsey expects to deliver positive comps.
“Given that first quarter tends to be the least important quarter, we expect companies to maintain annual guidance unless sales are meaningfully below plan and/or gross margin is worse than expected due to higher-than expected markdowns to clear the overhang of seasonal merchandise,” Telsey said.
The firm noted that the “gap in growth between total inventory and sales at the end of [fourth quarter of 2015] was 3 percent, which we would typically view as manageable relative to margins, but many companies had an inventory hangover as it relates to seasonal product.”
Telsey said Macy’s and Kohl’s have been making “concerted efforts” to reduce inventory, but the sector as a whole will feel the impact of a “challenging first quarter.”
With Stage Stores, Telsey said she expected “ongoing pressure from stores exposed to the Southern-oil markets and border along Mexico, but are concerned that the storms in key markets such as Houston and through the South Central region could have created incremental pressure on sales.”