August: Dreaming of Higher Margins
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At first glance, performance in the back-to-school season appears to be defying negative expectations, with retailer after retailer reporting strong comp sales.
August's headlines implied that retailers continued to weather the economic, political and tropical storms successfully, with almost two-thirds of retailers in our subset reporting monthly comps that beat expectations.
As we have said many times, however, comp sales do not tell the entire story. Beneath the surface we find evidence that, heading into Q3, retailers are likely pursuing sales performance at the expense of profitability in almost all segments but luxury.
As we have been tracking, and as a recent Bloomberg article discussed, second quarter earnings per share (EPS) for 43 S&P 500 retailers gained an average of 11% -- the smallest increase in eight quarters.
While EPS is one measure to view retail profitablility, we prefer a simpler headline number that's open to less interpretation – gross margin. Drilling down into the numbers we see that, while there were winners and losers, a gap is developing between comp sales and gross margin rate. This is particularly evident in Specialty Apparel, with Women's and Teen's showing the sharpest contrasts.
Surveying stores, we continue to see heavy promotions in all channels, including online. Seasonal sales began earlier this year as the competition for consumers' carefully allocated back-to-school budgets heated up.Follow this link to download the AlixPartners Comp Sales Report for August 2011.
The pressure on margins will only increase heading into Q3 as the full force of the raw material inflation we have been talking about since last Fall begins to hit store shelves.
Our AlixPartners' Retail Cost of Goods survey conducted in January and Febuary 2011 showed that retailers expected cost of goods increases of 15-20% to hit the store shelves most heavily in August; retailers are now finding out for sure to what extent they can expect to pass those increases on to consumers.
Earlier in the year, many retailers expressed confidence in their ability to raise prices strategically going forward across more elastic product categories. This was largely based on price testing done in Q1 and Q2. Given the economic headwinds facing retailers in Q3 and Q4, we do not share this confidence. What may have proved elastic in Q1 is less likely to be so in Q3 barring a dramatic global economic turnaround.
With plunging consumer confidence (the University of Michigan Index fell for the third consecutive month to 55.7, the lowest level since November, 2008) and stagnant employment numbers (the jobless rate held steady at 9.1%, or 16.2% including the underemployed), we believe it is critical for retailers to continue to protect their margins by streamlining operations, cutting costs and refining promotional strategies as they head into this increasingly challenging retail environment. Retailers are dreamers – that's what makes the business fun. But those that are dreaming of passing along price increases and higher full-price sell through, could wake up to find out their dream was actually a nightmare.
For comments and additional information, please reply to retail@alixpartners.com
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