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Retailers gird for the worst earnings season since 2008-2009

  • This earnings season could be the sector's worst since 2008-2009
  • Amazon has generated a quarter of retail sales growth
Pedestrians walk by Macy's flagship store in Herald Square in New York.
Getty Images
Pedestrians walk by Macy's flagship store in Herald Square in New York.

I recently called my old friend Ken Perkins for a preview on the earnings season for retailers, which starts in earnest Thursday with Macy's and Kohl's. Ken has been a retail consultant and analyst for many years as head of RetailMetrics.com. When I cheerfully asked, "Any signs of a bottom for these guys?," he said, "I don't see it" and then rattled off this depressing string of statistics:

  1. Of the 114 publicly traded retailers he follows, 26 (22%) are expected to lose money, the most since the 2008-2009 recession;
  2. 61% are expected to post lower year-over-year (YOY) earnings;
  3. 46% are expecting YOY revenue declines.

His glum evaluation: "This could be the worst performance for the retailers since the Great Recession."

Yikes! We all know retail is in upheaval, but something has happened in the last few months. We seem to have reached some kind of tipping point. Retailers big and small have been beset by a plague of problems:

  1. sales shifting to the internet;
  2. the proliferation of fast fashion outlets;
  3. the proliferation of private labels;
  4. the shift to "experiences" like travel and restaurants rather than buying apparel;
  5. the oversupply of retail outlets in general.

You might think that retail sales are collapsing, but they're not. The National Retail Federation estimates retail sales were up 3.8% in 2016. Internet Retailer, which analyzes online sales, has a similar figure. They estimate that e-commerce represented 13.3% of total retail sales in Q4 compared with 12.0% in Q4 of 2015. They factor out items not normally bought online, like automobiles, fuel, and bar and restaurant sales.

More important is the influence of Amazon. The total value of transactions from U.S. consumers on Amazon.com reached $147.0 billion in 2016, about $35 billion more than 2015 (these are estimates from Internet Retailer and ChannelAdvisor Corp.). They estimate that total online retail sales grew about $53 billion last year, to $394.8 billion from $341.7 billion in 2015.

That means that Amazon comprised 65.9% of the growth in U.S. online retail last year, and they separately estimate it was 27.4% of the increase in the total retail market.

Think about that. One company was a quarter of all growth in retail sales.

How do you compete against that?

In talking to retail traders, what I find most interesting is the almost universal belief that Amazon does not seem to care what it costs to be "top of mind," that is, they don't care how much they have to spend, they want you to think of them first. For everything. They want to be the place where you buy and the price to them is really secondary.

If that means being cheapest, or free delivery, or advertising, whatever top of mind means, they want to be that. They will make the investment in that relationship to be top of mind. Everything in retail is an outcome of that. Amazon is not very sensitive to margin. They are willing to spend anything to buy sales, and that crushes everyone below them.

To a certain extent, Wal-Mart is also willing to spend a lot to be top of mind to their clients.

What does this mean for other companies? Take Target--which is expected to do $70 billion in revenues in 2017, compared to an estimated $166 billion for Amazon, and nearly $500 billion for Wal-Mart. How do you compete when you are dealing with companies that have three to six times your revenues and are willing to do anything to increase sales? It's hard for Target--or Kroger, or anyone else--to keep up.

On top of that, add deflation, or bad weather--and it becomes tough to hit your numbers. There is no margin for error because of the pressure Amazon and Wal-Mart are putting on the business in terms of pricing and delivery.

So where does it end? It's not clear, but it doesn't end here. That's why I want to hear guidance from the retailers--full year guidance, not that it necessarily means too much because things are changing fast. There aren't many retailers who have a good sense of what their margins will be even a year from now, and certainly not five years from now.

But you can be sure some brave analysts are going to ask the One Big Question: does Amazon and Wal-Mart end up with all the business?

No. A number of retailers are holding up, including the home improvement group (Home Depot, Lowe's), the discounters (TJX, Ross Stores), select beauty companies (Ulta, E.L.F.), and a few specialty retailers that recently went public are also holding up well (Canada Goose, Floor & Decor).

But the overall trend is clear: if the whole industry is growing by $130 billion a year, Amazon is taking a huge chunk of that--more than a quarter. And they are taking market share from others.

What's it all mean? "In a free market economy, it's good to be the consumer, bad to be the retailer," Perkins concluded.

It also means that you can expect more mergers like Coach-Kate Spade deal, which makes sense in this context. Coach generates tremendous cash flow, but they have largely saturated North America. They can only grow by reinvesting cash flow into new businesses. There's not a lot of earnings growth, but the cash flow can be used to fund new businesses. The best strategy is to buy existing brands as cheap as possible and use their existing global reach marketing to expand.

And they are getting them cheaper. Soraya Benitez, retail analyst at Cougar Trading, noted that Kate Spade was bought at a multiple of 10 times trailing cash flow (EBIDTA), but the stock has traded at 15 x EBIDTA in the past. "There's a massive valuation reset going on," she noted.