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Inflation Fears Expected to Overshadow Retail Earnings

Friday, 18 Feb 2011 | 2:04 PM ET

Retail stock watchers get ready: Next week a large majority of retailers will be reporting earnings from the holiday quarter.

Woman window shopping on a snowy street
Stuart O'Sullivan | Stone | Getty Images
Woman window shopping on a snowy street

While many analysts expect sales numbers to be strong, Wall Street is expecting earnings conference calls to serve more as inflation strategy sessions than as quarterly reviews. The pleased executive voices on conference calls are expected to quickly turn to voices of concern.

The rising cost of cotton, now at 150-year highs, is certainly grabbing headlines, but the weakening U.S. dollar as well as increasing labor, freight and production costs are all major concerns for retailers in 2011. Investors want to know if growth will be muted and gross margins squeezed, as a result.

Citi analyst Deborah Weinswig certainly thinks the rising input costs will have a negative impact. As a result, she is raising her inflation expectations from 4 percent to 6 percent in apparel for the first half of this year and from 13 percent to 15 percent in the second half.

Additionally, Weinswig lowered her full-year 2011 EPS estimates on seven major broad-line retailers: JCPenney , Kohls, Macy's, Saks, Target , Walmart and Nordstrom .

Weinswig is also lowered her target prices for Kohls, Macy's and Walmart shares, while raising targets for JCPenney, Nordstrom and Saks shares.

Jan Kniffen, CEO of J. Rogers Kniffen Worldwide Enterprises, told CNBC that after he spoke with vendors and apparel retailers at the MAGIC conference in Las Vegas, it seems inflation for second half of 2011 is running more in the 12 percent range for large apparel retailers, and even higher for the smaller players.

So what will retailers do to maintain margins in this enivornment?

Analysts largely agree that at least some of the costs will have to be passed on to the consumer.

"They showed they could do that during the recession, and now is their time to show it again."" -CEO, Telsey Advisory Group, Dana Telsey

Craig Johnson, president of Customer Growth Partners, remains cautiously optimistic.

“The 90 percent of people with jobs, who account for 96 percent of retail sales, are clearly spending again," Johnson said. "But unlike the mid-2000's bubble years, they are spending smartly and strategically—and out of current income rather than with ‘plastic'—across all categories."

But still he said he thinks there are questions as the industry enters a new fiscal year.

"The question is whether they can pass along rising input costs to today’s much smarter shoppers—or whether these shopping app-equipped consumers will simply get the same item elsewhere, or online,” he said.

Dana Telsey of Telsey Advisory Group said retailers that will be best positioned to successfully pass along costs are those on the higher-end as opposed to mid- to lower-end, and those that cater to more novelty items than to basics.

Kniffen agrees. "The more affluent the customer, the more that can be passed through, as long as the fashion is right," he said.

As far as earnings results go, there will be winners and losers. Telsey thinks Macy's and Limited will report strong fourth-quarter earnings and expects an improvement in Chico's.

Telsey is watching the Gap's earnings after the company raised its guidance as well as Home Depot and Lowe's to see the macro-environment impact on sales.

As retail executives discuss inflation strategy, they will have to also address areas of potential growth, something Telsey watches closely.

"Growth initiatives are also key because many of the growth incentives—whether it's online, international or outlet—generate higher levels of profitability than the core stores," she said.

Johnson thinks the strongest retail sectors in 2011 with be home-related, including home furnishing retailers Bed Bath and Beyond and Williams-Sonoma as well as home-improvement players Home Depot and Lowe's as pent-up demand comes into the market.

Johnson also sees luxury retailers, particulary Tiffany and Signet, continuing the stellar growth seen during the holiday season.

Perhaps this period of inflation will not turn out to be as detrimental as feared for retailers. After all, the "great recession" just ended, and retailers made it through and are expected to report strong earnings next week.

As Telsey puts it: "We're going from a period of uncertainty to a period of clarity. We're getting clarity because we've had nearly two months of sales now in 2011, orders have been placed for the back half of the year, retailers know what the pricing pressures are and can be flexible and adapt. They showed they could do that during the recession, and now is their time to show it again."

Questions? Comments? Email us at consumernation@cnbc.com

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