Back-to-school investing preview: Possible recession looms over retailers' busiest half of the year

Published Sat, Jun 25 20227:23 AM EDT

Christina Cheddar Berk @in/christina-cheddar-berk-b864404/

Every other week, beginning in May, Morning Consult polls consumers about back-to-school spending plans. The results of its latest survey were startling. There was a 10-point pop from the prior poll in the number of parents who say they can't afford backpacks, notebooks, new jeans and sneakers, and other supplies. "The drop in the number of parents who feel they can afford back to school in just the last couple of weeks is frankly alarming," said Claire Tassin, a retail and e-commerce analyst at the decision intelligence company. "It's families just knowing that they have this big looming shopping to do and knowing that budgets are stressed or stretched thin, so that's where that stress is coming from," she said. Just more than a third of parents, some 36%, said they felt they could buy supplies for their kids without any issues. Last year, armed with stimulus checks and advance child tax credits, more than half said they felt the same way. And those who reported being stressed about back-to-school shopping has jumped seven percentage points over the last two weeks, Tassin said. The souring mood among consumers has been measured by other gauges as well. Notably, the widely followed University of Michigan consumer sentiment survey on Friday showed a final reading for June sunk to a record low of 50. That compares with a 58.4 reading in May and is down 41.5% from a year ago. Quickly eroding consumer confidence will challenge retailers in the second half of the year. But because parents view back-to-school items as necessities, sales estimates could be strong, industry watchers said. Children quickly grow out of clothes and the items must be replaced. So this spending is prioritized. Plus, higher prices will boost the top-line number. That means retailers with the right inventory, fashion and value could come out ahead. Key takeaways for investors Multiple surveys show consumers are rapidly growing more stressed and selective in their spending. Quickly rising prices have been blamed for the souring mood. Money that consumers tucked away during the pandemic isn't easing their concerns, but it is providing a cushion. Amazon has moved its Prime Day sales event back to mid-June, which should draw in some early back-to-school shoppers. As usual, other retailers will compete with the event by offering their own deals. Retailers will need to take care with promotions because costs in the supply chain haven't fully trickled down to consumers, according to PwC's Kelly Pedersen. But Randy Hare, director of equity research at Huntington National Bank, warned that could be "a little bit of a rosy picture." The real benefit of back-to-school spending is the addition of all those impulse purchases parents throw into the cart while they're shopping, he said. This year, he doesn't expect as much of that to happen. "I do think consumers are able to purchase the necessities," he said. "This isn't going to be the recessionary type of environment where they have to decide which of these really important items they can buy." A recent UBS survey did find some consumers were planning to skip items on the back-to-school shopping list. The highest percentage of consumers since 2013 said they plan to spend less on back-to-school supplies due to the state of the economy. The same percentage — 24% — said they plan to reuse some of last year's items. Compare that to last year, when 18% said the same. UBS said this is the highest percentage that answered this way in nine years. Tapping pandemic nest eggs The blame for the darkening mood is falling squarely on the battering from inflation. Consumers entered this period of higher prices in strong position. Unemployment was — and has remained low — and saving rates were high. But inflation has been brutal, eroding wage gains and siphoning off rainy day funds, particularly among lower income consumers. In April, Americans' personal savings rate fell 4.4%, marking the biggest drop since 2008, according to the Bureau of Economic Analysis. No doubt consumers have cut back on savings to offset the higher prices they are seeing. Barclays estimates Americans socked away about $2.5 trillion during the pandemic, helped by stimulus checks and forgoing spending on travel and entertainment. Even if current conditions persist, it will likely take until next year to drain the excess cash, Barclays predicts. But consumers are already changing their spending patterns, according to market researcher the NPD Group. It said the traditional ramp-up in retail spending over the Memorial Day weekend didn't materialize this year, and year-over-year unit declines are "volatile." NPD's data also shows that the lift in spending into the Father's Day holiday was weaker this year than it was over the past couple of years. Marshal Cohen, chief industry analyst at NPD Group, said consumers are picking and choosing where they want to spend their money and there's a lot of competition for those dollars from vacations and events like concerts. According to an NPD survey of 1,014 U.S. consumers published in May, 83% are planning to make changes to reduce their spending on products in the next three to six months. A shift away from products to services had been widely predicted, but the intensity of the inflation was not, analysts said. The spike in oil prices that followed the war in the Ukraine has exacerbated the higher prices that stemmed from supply chain disruptions. Consumers are worried about their budgets and how are they are "going to put the entire puzzle together," said Tassin. Morning Consult's survey showed that shoppers who are already starting to buy back-to-school items are increasing their budgets. As a result, the number of people who expect to spend more than $500 readying their kids for class has grown to 25% from 11% in a month's time, she said. Their survey polled 2,760 parents in the U.S. The early shoppers tend to be less financially stressed, Tassin said. And the increases likely reflect what they are seeing at the store, she said. "There's a little bit of a 'treat yourself' mentality," said John Zolidis, president and found of Quo Vadis Capital. That attitude is shaping what consumers are buying, he said, citing recent conversations he has had with retail management teams for his opinion. One example he called out is Ulta Beauty , which has seen a recent pick up in fragrance sales, a category that tends to be most popular during the holiday season. Zolidis said it shows consumers are looking forward to going to social events. But the perception among investors is that retailers will see weakening sales from quarter to quarter and there is a concern that companies will be stuck with excess inventory as preferences change, he said. This possibility was driven home by Target's profit warning in early June. The discounter expects its second-quarter profit margins will be around 2% as it marks down items and cancels orders to get unwanted merchandise off the shelves. "Target is the poster child for not getting it right," Zolidis said. But the company took the hit to set itself up for the future. "They want to win at back-to-school." Target shares have fallen 35.5% since January, and the stock has continued to hit new 52-week lows since that announcement. 'It's going to be a bloodbath' Donna Hoffman, a professor of marketing at George Washington University, expects a very promotional season with Target, Walmart and Amazon locked in a price war. Amazon has moved its Prime Day sales event back to mid-July, which puts the event squarely in the back-to-school shopping season. Target has responded by announcing its own competing Deal Days event. "I think it's going to be a bloodbath," Hoffman said, explaining that retailers know that consumers will be "looking at every dollar and seeing where they can cut." Amazon usually uses Prime Day as a way to drive loyalty among its members, and this year will be no different. It has created Prime Stampcard , a program that allows members to earn shopping credit by using Prime features like steaming music and video or reading a Kindle book. According to Hoffman, Amazon is trying to reinforce the value it offers its members at a time when consumers might be reconsidering how many subscriptions they want to have. Kelly Pedersen, a partner at PwC, said retailers will need to be "surgical" about how they think about promotions because there are still costs in the supply chain that have yet to trickle down to consumers. "That's why I think there's still expectations around increasing inflation here in the next few months," he said. That means retailers will be looking to find the few categories that will drive the most customers into the store with targeted promotions. Even state governments are dangling discounts. This week, New Jersey approved a back-to-school tax holiday from Aug. 27 to Sept. 5 , which removes state sales tax on big ticket items such as computers. There has been a sharp increase in the number of state sales tax holidays this year, according to Katherine Loughead, a senior policy analyst at the Tax Foundation. The Garden State was the 20th state to add one, she said. That's up from 17 last year, and the highest number since 2010, when 19 states had such offers. "Sales tax holidays are good politics, but they're not really good policy," said Loughead, who said the tax offers aren't an efficient way to ease the tax burden. With tax holidays, consumers save "a pretty trivial amount of money," she said. Also, these events don't create new demand and boost economic growth. Instead, consumers simply shift the timing of what they were already going to buy, which can make things more complex for retailers at a time when they are already struggling to manage inventories and staffing levels. 'We've got a buyer's market' "We've got a buyers' market," NPD's Cohen said. He expects the promotional environment will continue into the holiday season, with deals starting early in October. "And you'll see very aggressive Black Friday deals as retailers are going to try to use price as the lure to get consumers to shop," he said. Cohen said in most recessionary periods consumer spending starts to trail off after the economy pulls back. This time around, he anticipates that consumers will lead the economy into a recession, with a sharp pullback in spending. "So that means we're going to have a very tricky and challenging fourth quarter," Cohen said. When budgets are tight, it's usually a time for Walmart to shine, but the stock has been under severe pressure since it reported its first-quarter results in May. Year-to-date the stock is down 14%. Huntington owns Walmart shares, and Hare said he is watching to see how its next quarter plays out. He said he hopes that some of the issues that hurt the first quarter are behind Walmart and that it fully accounted for the higher fuel costs that have been hurting its profits when it gave its updated forecast. "We do think sales are strong and we do think that the trade down effect is going to be a positive for them," Hare said. UBS analyst Jay Sole said his firm's market research shows rising stress levels over the past month. It reinforces Sole's expectation that the stocks of softlines retailers — which sell apparel, accessories and goods like bedding — will struggle. The group has fallen more than 33% year to date, underperforming the S & P 500 Index , Sole said in research note on Wednesday. "Yet, we see more stock price pressure ahead since our conversations with investors suggest few are willing to buy Softline stocks in a decelerating sales environment," Sole said. He pointed to department store stocks as the group that is most at risk. He has a sell rating on Dillard's , Kohl's , Nordstrom and Macy's , and said he doesn't believe the companies' challenges are fully priced into the stocks. Sole wrote that he expects premium products will fare better in the months ahead because these companies can adapt as more apparel dollars continue to shift online. Of the 40 softline retail stocks UBS covers, the most premium, based on adjusted direct-to-consumer merchandise margin, are Canada Goose , Capri and Lululemon . He also says investors should favor brands over retailers, and look for those companies are entering new categories or markets. Nike , Levi's , Skechers , Deckers , Ralph Lauren , On Holding and Bath & Body Works are the stocks Sole has identified that have strong growth outlooks that aren't full appreciated by the market. Zolidis said he favors sporting goods retailers Academy Sports and Outdoors and Dick's Sporting Goods . Both companies can benefit from back to school as parents stock up on clothes, shoes and gear for sports teams. Academy shares have fallen 12% year to date, while Dick's is down nearly 27%. —CNBC's Michael Bloom contributed to this report.