May 12, 2017

U.S. Retailers Report Mixed Q1 Earnings

by Jharonne Martis

The bulk of department stores reported earnings this week, and the results were not impressive. The strongest result came from JW Nordstrom’s Rack stores division with a 2.3% SSS, underlining the strong consumer demand for promotions. The remainder of the department stores posted negative same store sales (SSS) and weak earnings as they continue to lose market share to off-price retailers like TJX, ROST and Burlington Stores, all scheduled to report next week (Exhibit 1).

Exhibit 1: Department Stores vs. Off-Price Retailers Same Store Sales Estimates/Actuals: Q1 2017

Source: Thomson Reuters I/B/E/S estimates

Macy’s missed its earnings, revenue and SSS estimates. The problem with the department stores is that retail sales have declined, and as a result they are sitting on huge amounts of inventory they are discounting steeply. Consequently, margins are hurting.

Department stores continue to lose market share to online competition and off-price retailers, which sell designer clothing for less.  The bulk of the merchandise at the department stores consists of apparel brands including Ralph Lauren, Tommy Hilfiger, Jessica Simpson, Martha Stewart, etc., which are not relevant to millennials – the largest consumer group in the U.S.

Thus, in an effort to compete with the likes of off-price retailers, Macy’s plans to open 30 more Backstage-branded shops in Macy’s full-price stores by the end of 2017, and close about 100 of its locations. Still, when looking at the Thomson Reuters projections for the next four quarters, both earnings and revenue growth are still expected to be negative for the most part.

Credit worries

According to StarMine, this might not be the end of the bad news. To determine which department stores may be in danger of default in 2017, we looked at our StarMine Combined Credit Risk model, the most comprehensive StarMine credit model. Several department stores, including JC Penney and Sears, had been in the riskiest quartile of all retailers likely to default in the United States for some time now. Last year, Macy’s score was 25 and dropped to a score of 13 this year. Six out of seven department stores rank in the bottom quartile of the StarMine Combined Credit Risk model score. These scores correspond to implied credit ratings of BBB- or worse, suggesting these stores are not financially stable.  For example, Macy’s has a score of 13 corresponding to a BB implied credit rating, according to the model.

Exhibit 2: StarMine Combined Credit Risk Model Scores – Department Stores

Source: Thomson Reuters Eikon

So where are consumers shopping?

It’s clear from the list that the strongest reported earnings growth rates so far, that consumers prefer experiences over things, with Netflix boasting the strongest growth rate at 566.7%. What’s more, the strong housing market is boosting earnings for the household appliances, home furnishing, household products and homebuilding industries, suggesting that consumers continue to invest in the stay at home experience.

Exhibit 3: Q1 2017 Strongest Reported – Earnings Growth Rates

Source: Thomson Reuters I/B/E/S estimates

On the flip side, the weakest earnings growth rates are coming from the apparel group.  This sector has been struggling for some time. Likewise, department stores sell a lot of apparel merchandise and have been struggling as well.  Other than the off-the shoulder fashion trend last year, there’s been a lack of a “must-have” fashion trend in 2017. Consumers already have enough athleisure and clothing in their closets. And millennials don’t particularly shop at department stores.

Exhibit 4: Q1 2017 Weakest Reported – Earnings Growth Rates

Source: Thomson Reuters I/B/E/S estimates

Negative guidance – next quarter

Retailers are already warning us not to expect much in the next reporting cycle.  For Q2 2017, there have been 25 negative EPS preannouncements issued compared to only 7 positive EPS pre-announcements. This is more than twice the amount of negative guidance from the previous week (Exhibit 5). The bulk of the negative guidance (21%) comes from the apparel sector.

 Exhibit 5: Q2 2017 Earnings and Revenue Guidance

Source: Thomson Reuters I/B/E/S estimates

Still to report – expected winners: Q1 2017

When looking at the companies that have yet to report, it’s interesting to see that the companies with the strongest earnings growth rates are in the beauty industry, including Coty and Inter Parfums. Ulta Beauty has the strongest SSS estimate in our retail universe, and analysts are bullish that the retailer is poised for a healthy future.

Exhibit 6: Q1 2017 Strongest Earnings Growth Rate Estimates

Source: Thomson Reuters I/B/E/S estimates

Still to report – expected losers: Q1 2017

The weakest growth estimates are from G-III Apparel Group, Fossil and Vera Bradley. They all sell their merchandise in department stores such as Macy’s. Accordingly, these names are struggling from weak sales and negative earnings growth. Other apparel stores like Express that are mall-based are experiencing weak store traffic, and e-commerce challenges.

Exhibit 7: Q1 2017 Weakest Earnings Growth Rate Estimates

Source: Thomson Reuters I/B/E/S estimates

Next Week Earnings – Week of May 15

Looking forward to next week, we are seeing similar trends; weakness among apparel stores, such as Gap. Meanwhile, off-price retailers are expected to post healthy earnings growth rates. Still, Home Depot is on top with a 4.0% SSS, and strongest earnings growth rate estimate of 11.8%.

Exhibit 8: Companies reporting Q1 2017 Earnings: Week of May 15

Source: Thomson Reuters I/B/E/S estimates

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