What this week’s retail earnings tell us about consumers and our stocks that depend on them

Target (TGT) missed on earnings. Lowe's (LOW) provided mixed results. Home Depot (HD) fared better. Walmart (WMT) beat estimates but warned its customers were focusing more on lower prices.

Results were all over the map for this week of retail earnings. But dig a little deeper, and there were some very clear themes — regardless of results — that showed us how the consumer is faring during this period of high inflation. They also provide a window into our holdings with exposure to the everyday consumer, namely Costco (COST), Amazon (AMZN) and Apple (AAPL).

Here are some common threads before we get the bottom line on our Club holdings.

Covid pandemic shortages eventually became post-pandemic oversupply, which is why the retail industry has been suffering from what Jim Cramer has called an inventory glut recession.

• During the pandemic, there was a lot of demand for retail goods. Giants like Walmart and Target overestimated the consumer demand and ended up ordering in excess. Fast forward to today, both retailers have been struggling to sell the surplus and are now sitting on stale inventory. This excess of goods has ultimately put pressure on their profits as they have been forced to mark down goods in order to clear out some of that inventory.

In late July, prior to reporting its fiscal second quarter earnings this week, Walmart cut its quarterly profit expectations and full-year guidance. Similarly, Target issued two warnings — one in May and another in June — preparing investors that its then-upcoming quarterly results would take a hit.

• While Walmart reported 8.4% year-over-year growth in sales to $152.86 billion, customers focused on lower-margin product purchases — which in part, weighed on profitability. Though earnings-per-share did beat revised estimates. Walmart CEO Doug McMillon told CNBC on Tuesday, "People are really price-focused now, regardless of income level." New customers and more frequent trips from households with annual incomes of $100,000 or more helped boost sales.
• Target met analyst revenue expectations of $26 billion but reported much lower-than-expected Q2 earnings, a hard miss on its bottom line. On Target's post-earnings call Wednesday, Chief Growth Officer Christina Hennington said customers are feeling the bite of inflation, stretching their budgets by taking advantage of promotions and consolidating store trips. She said Target shoppers still have spending power, but "confidence in their personal finances continues to wane."

Both retailers were also compelled to cancel billions worth in orders and pricing down their inventory, so they're better positioned for fresh inventory as the holidays roll around. Both of them also signaled that customers are mindful of inflation and are adjusting their spending habits accordingly.

This week of retail earnings revealed that consumers are redirecting their spending patterns, but overall demand is resilient. That was seen in Walmart's commentary and at Home Depot and Lowe's.

• In Walmart's earnings call, in addition to talking about those mid- to higher-income customers looking for value, management mentioned that shoppers are buying less high-margin discretionary items, like electronics, but they're spending more on lower-margin like groceries. That reflects a consumer pressured by inflation but still able to spend in a cost-effective way.
• Home Depot beat analyst expectations with its second quarter results, delivering its highest quarterly sales and earnings in the company's history. The home improvement giant reported consumers are spending on renovations, even in a weak housing market. On the post-earnings call, management said customers are not trading down to less expensive items despite inflation. The company saw growth from both professional and do-it-yourself (DIY) projects.
• Lowe's provided mixed quarterly results in its second quarter. It appeared to come in weaker than rival Home Depot since it markets more to DIY consumers who are likely monitoring large purchases. For the quarter, DIY customer sales were impacted in part by lower demand in some discretionary categories, offset by double digit growth among pro contractors. While the mix at Lowe's is different, CEO Marvin Ellison told CNBC: "Rather than the DIY consumer trading down like you hear from some retailers, in many cases we were seeing the opposite. ... The customer's actually trading up to innovation and trading up for new."

Many retailers have been experiencing margin pressures from not only inventory oversupply, but also from elevated inflation across the board. They're dealing with higher labor costs and input costs — and how much of those they can pass along to consumers in the form of price hikes on their products, which goes to margins.

As mentioned earlier, Walmart and Target mischaracterized the level and mix of inventory they needed and now they're stuck with stuff they're forced to mark down. We see this mismanagement as unacceptable because these retailers have the data that could have better prepared them.

• Target took an almost 90% hit to earnings-per-share from a year ago, resulting from price markdowns on their excess inventory, which impacted their margins.
• In its second quarter earnings statement, Walmart CEO Doug McMillon said the company's steps to improve inventory levels and put pressure on its profit margins for the second quarter.

However, margin pain for retailers is often times a boon to consumers, who browse the sale racks for bargains, especially in these tough times. While not nearly as bad as Target's year-over-year EPS decline, Walmart's Q2 profit of $1.77 per share was a penny shy of the year-ago period.

At a higher level view, the government reported retail sales for July this week.

• The $682.8 billion in total sales last month was unchanged from June's revised number. Estimates had called for a 0.1% increase. It's worth noting these numbers are adjusted seasonally — but not for inflation — and came during a month when the consumer price index also was flat.
• Retail sales in July, excluding autos, rose 0.4%, which was much higher than expectations. Month-over-month auto sales fell 3.4%.

Overall, this signals that consumers have been holding up in the face of inflationary pressures. They're still looking for value in the retail space — perhaps, a reason why big-ticket items like cars and building materials were down for the month — but they're are not shying away from spending.

What does all this mean for our Club holdings that depend on the consumer? Overall, we see a positive retail readthrough for Costco, Amazon and Apple.

• Costco, which we see as a better alternative to Walmart, is holding up in a slowing economy because of its strong inventory management and loyal membership program. We don't get Costco's latest earnings until next month. But the company reports sales figures on a monthly basis and they have been solid. Consumers are price-sensitive and looking for deals. One way they can do that is by buying in bulk at Costco. Costco is in a better position than Walmart and Target because by selling bulk, it can offer lower per unit pricing than competitors. Costco has also proven to manage its inventory much better than Walmart and Target meaning that it doesn't have to mark down selling prices at the expense of profit margins. Investors like that because if they have faith in management, then they will pay a higher multiple for the stock due to the increased confidence they have in future earnings potential.
• Amazon has been holding up as consumers continue to shift to online shopping. Like Costco, it has a membership model through Prime. But unlike Costco, Prime offers much more than just great pricing on retail goods such as streaming (think the bundle). Walmart is trying to make its Prime-like offering Walmart+ more attractive by teaming up with Paramount+ to offer a streaming value-add. The other thing Amazon has going for it as we look ahead is that while the company did overbuild in recent quarters, profitability is likely set to improve from here as the company grows into that excess capacity. At the same time, it's also reducing the size of its workforce and realizing the benefits of the recent pullback in energy prices.
• We also expect resilient results from Apple to continue as their anticipated new iPhone release comes this fall. Apple operates retails stores and also sells things direct to consumers online. Apple also offers high-margin subscription services that are recurring in nature and something consumers tend to pay without even thinking about it. Apple's consumer tends to be at the higher-end of the income brackets a demographic that feels inflation less because basic necessities account for a smaller portion of disposable income. While there will be some impact on demand, their customer base is better positioned to weather inflation compared to let's say Walmart and Target customers. Case in point, in a note to clients, Keybanc analysts said demand appears more resilient for higher-end iPhone models and more "muted" for lower-end models. Moreover, Apple may well feel some impact from rising impact costs, but their inventory issue is the opposite of Walmart and Target as recent sales performance wasn't restricted due to a need to markdown obsolete inventory but rather a lack of supply in certain product categories including the Mac and iPad. There are benefits of having a logistical master at the helm when supply chain bottlenecks are one of the most pressing headwinds facing the economy.

— Programming note: On CNBC television Friday night, the network is doing a special called "Battle for the Consumer." It airs at 6 p.m. ET.

(Jim Cramer's Charitable Trust is long COST, AMZN, AAPL. See here for a full list of the stocks.)

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