In a challenging holiday season, appealing merchandise at an attractive price point is the key to salvaging gross margins.

This story first appeared in the December 26, 2007 issue of WWD. Subscribe Today.

More than any other factor, financial experts said holiday results this year will come down to product. Industry experts differ in their expectations for fourth-quarter margins because of a season marked by macroeconomics that squeezed consumers, as well as stormy weather that disrupted shopping across large swaths of the U.S. Some predicted that final numbers will defy expectations, while others caution that being promotional too early in the season will adversely affect fourth-quarter margins.

There is consensus, however, that the quarter is likely to shape up to be a retailer-by-retailer story.

“No one has the perfect crystal ball,” said Craig Johnson, president of Customer Growth Partners. “You never know what’s hot from one week to the next. If you have a nimble supply chain, you can get it right.”

There are headwinds for consumers this year that could be a factor for some — although not all — retailers, analysts said. Economic pressures have made holiday shopping even more competitive.

“In this type of environment, it is more important for the retailer to have something new and exciting and interesting,” said Howard Tubin, director of equity research at RBC Capital Markets. “If you don’t give them a reason to shop, they won’t shop.”

“The customer has to want what you’re offering,” said Richard Jaffe, analyst at Stifel Nicolaus & Co. Inc. “There are issues about attractiveness of product, competitiveness in the marketplace and the willingness of the consumer to spend.”

If consumers are not excited by what is in a store, little else matters.

“If you have the right product, margins should be fine,” said Christine Chen, analyst and vice president equity research at Needham & Co. “The big unknown is how promotional the environment will get and the percentage of planned promotions versus unplanned promotions.”

The fallout from high gas prices, the housing slowdown and tight credit makes consumers more attuned to the lure of discounted product.

“Shoppers are more keenly aware of discounts this year than in past years,” said Stanley Officina, president of Ultimate Financial Solutions. “We don’t expect substantial gross margins at retail.”

It doesn’t matter how good an inventory position is, he said. Whatever price is paid for an item if it has to be marked down, it affects margins.

Not all retailers are expecting a poor showing for the quarter. Customer Growth Partners’ Johnson said he expects retail margins in all sectors to be better than anticipated based on strong top-line sales growth. In the apparel sphere, however, results could be more mixed, he said. Individual store performances are varied, with some in the ditch and some showing signs of a comeback. In general, mainline women’s apparel is not doing well, but youth stores are, he said.

In the specialty sector, American Eagle Outfitters and J. Crew could post improving gross margins because they have had the right product and have tightly controlled inventory, some analysts said. Aéropostale also could do very well in the fourth quarter, sources said.

“Aéropostale is in, and as the kids would say, ‘American Eagle is so over,'” said Johnson. The margins of well-run companies will follow the top line, he said.

Broad-line retailers could face pressures as well, with tough comparisons year-over-year.

“A lot of retailers planned their inventories more conservatively. There is more of a gross margin risk this year versus last year, with slow top-line growth and the promotional environment. A lot more business is being done around promotion events. More customers are also buying closer to need, so we have no idea how promotional stores are going to get. But no one is overreacting yet, there are still no aggressive unplanned markdowns,” said Deborah Weinswig, analyst at Citigroup, of the broad-lines sector.

Saks, Kohl’s, J.C. Penney and Nordstrom all are expected to report negative margins partly due to tough comparisons year-over-year, Weinswig said. Macy’s is expected to be flat. For some retailers the fourth quarter will not be a good one for gross margins, which could have an impact since it is usually considered a good period, she said.

On the supply side, manufacturers and suppliers are also not immune to margin pressures.

“Most wholesale companies, if they were prudent, should have started to cut back or source more selectively coming into the fourth quarter. What has happened is that retailers in select cases have deferred and canceled certain orders,” said Michael Stanley, managing director, Rosenthal & Rosenthal. There were earlier indications that things were softer in the first two quarters of the year, he said.

Excess inventory at this stage could be more problematic than last year because the retail sources to dispose of that inventory have narrowed, Stanley said. For wholesalers, holding excess inventory could prove to be very problematic.

There is also the issue of markdowns, sources said. One financial source pointed out that, historically, certain retailers have used markdown allowances to fix their gross margins. “Retailers try to survive any way they can and it comes home to roost with importer or manufacturer, and they pass it on to their suppliers. It moves down the food chain. When things are tight, it affects everyone,” said one financial executive.

No matter what happens during the holiday season, the long-range impact of the period could be felt long after the fourth quarter closes.

“People save up for the holidays. The question is, what will happen to spending in 2008? Fourth-quarter expectations are so low,” said Chen.