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Investment

Why it's going to be tough to get a rally in retail this year

After a stellar earnings report, with a surprising 1.3 percent gain in same store sales, Target shares are up only 3 percent today, after dropping 23 percent for the year.

Huh? Target not only beat expectations, it raised full-year numbers by nearly 10 percent. But the stock is up a measly 3 percent. That tells you that the investing public is not that impressed.

A number of retailers have also reported a sequential improvement in business, including Home Depot, Kohl’s, JC Penney, and Nordstrom.

But there’s no significant rally in retail. Target trades at $56; it started the year around $73.

Yesterday there were dozens of retailer stocks trading at 52-week lows, including JC Penney, Buckle, Bed Bath & Beyond, Mattel, L Brands, Under Armour, Penske Automotive, Hibbert Sports, Cato, Express, Francesca’s Holdings, DSW, and even retail REITS like Tanger Factory Outlets.

Absent some sudden mass rush to the stores, it’s unlikely we will see a notable rally in retail until the fall, if at all. The reason: retailers are facing “revenue cliffs” and margin compression this year and it’s not clear to investors where the bottom is.

You can see this with Target, which after reporting $73.7 billion in revenue in 2016 is expected to report revenue of $69.4 billion this year, a decline of nearly 6 percent.

It’s the same story with most other retailers, but particularly department stores, all of which are looking at mid-single digit declines in revenue.

(2017 ests. Vs. 2016)

J.C. Penney: down 1 percent
Macy’s: down 7.4 percent
Kohl’s: down 3.6 percent

The exception is Nordstrom, expected to report a revenue gain of roughly 4 percent. Not surprisingly, Nordstrom is among the most successful at online sales and also runs a successful discount outlet in the form of Nordstrom Rack.

While there have been worries about an Amazon effect and online sales in general for several years, the “revenue cliff” is a relatively new phenomenon. Many retailers have struggled to increase revenues, but an outright reversal is pretty new. You can see this with Target, which went sideways for years before dropping this year:

(billions)

2017 (est.) $69.4
2016 $73.7
2015 $72.6
2014 $72.6
2013 $73.3

Source: Factset

Retailers rallied briefly a month ago on hopes that the companies would signal some imminent bottom in the sales slide. Target came as close as anyone when they reported a surprise rise in overall sales:

Q217: up 1.3 percent
Q117: down 1.3 percent
Q416: down 1.5 percent
Q316: down 0.2 percent
Q216: down 1.1 percent

Source: Factset

But retailers as a whole have given no indication a bottom was imminent.

For Charles Grom, who covers department stores for Gordon Haskett, the Amazon specter cast a pall over any hopes for an imminent bottom: “Second quarter numbers weren’t terrible, but the margin profile was a surprise, a lot of which was driven by Amazon and pricing pressures. They’re all looking for a broader strategy to overcome the secular headwinds they are facing, and most don’t have that.”

He did note that a few were trying to innovate: “JC Penney is adding appliances and getting Sephora, Kohl’s has got Under Armour, but there’s not much else. Investors don’t see any hope, and that’s why people are selling them.”

So where’s the bottom? Grom says he is mildly encouraged with the back-to-school season —Target and others also noted that August was off to a decent start — but says the real test will come in the holiday season.

Ken Perkins at Retail Metrics agrees. “The fourth quarter will be crucial. Investors want to see more than just a bottom, they want signs of growth. And they want to see that at a time when a lot of the sales are going online and the margins are lower.”

That’s a pretty tall order, but not a hopeless one. Grom today upgraded Target specifically because of the improvement in topline trends. And the company is making an effort to address the innovation issue: it is pushing forward with a massive store remodeling, as well as testing new digital strategies like same-day delivery.

Still, it’s not going to be easy convincing an investing public that has essentially left the industry for dead. Grom notes that the short-interest ratio for Target — the percentage of shares sold short — is about 10 percent, the highest it has been in years. With no interest from the investing public, that’s a problem.

But Grom is hopeful. He notes that roughly 24 million shares traded Wednesday, nearly four times normal volume. “A lot of that is clearly short covering,” he told me.

He also notes that Wal-Mart reports on Thursday. “If Wal-Mart can firm up the narrative on the group, then we may get another modest rally,” he said.

Source: Investment Cnbc
Why it's going to be tough to get a rally in retail this year

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