Consumer spending trailing consumer sentiment lower. Look at Home Depot

Published Tue, May 16 20238:51 AM EDT

Good luck figuring out the consumer this year. Recent consumer sentiment reports have been poor, so it's reasonable to assume the consumer spending backdrop has softened. That's essentially what Home Depot reported early Tuesday. Earnings were a couple pennies above expectations, but revenues were light. Same store sales were down 4.5% vs. forecast estimates of down in the 1% range. The average ticket was up 0.2%, but customer transactions (trips) fell 4.8%. Home Depot cited three issues: lumber deflation, unfavorable weather (particularly in California) and "more broad-based pressure across the business compared to when we reported fourth quarter results a few months ago." The company is cutting guidance due to the weaker lumber prices, weather and is also citing "further softening of demand relative to our expectations, and continued uncertainty regarding consumer demand." Atlanta-based HD now expects comparable sales for the year down 2%-5% (vs. the prior guidance of flat), and earnings down 7%-13% (vs. the prior guidance of down mid-single digits). Let's clear up a couple things here. First, lousy weather was widely anticipated. Second, lumber deflation is good, isn't it? I understand that it affects Home Depot's revenues, but whose side are we on? If we are on the side of the American consumer (I am), then lower lumber prices are good, right? That leaves the nebulous "softening of demand." CFO Richard McPhail told CNBC's Courtney Reagan that Home Depot saw continued softness in big ticket discretionary goods such as patio sets, grills, and appliances, but that the consumer still has a healthy balance sheet. "Our hypothesis is that this is a result of tighter monetary policy and credit conditions. We think the medium to long-term fundamentals of home improvement [are] strong," he told Reagan. In other words, some consumers seem to be deferring purchases of higher ticket items, but the consumer is still spending. Softer consumer already anticipated It's not like investors don't believe the "consumer is softening" story. Just look at the performance of retailers this year. Big Lots -45% Gap -29% Macy's -25% Kohl's -19% Dollar General -11% Dillard's -10% Best Buy -9% Nordstrom -7% Partly due to a strong comeback by Amazon (up 32% this year), the SPDR Retail ETF (XRT), an equal-weighted basket of 88 retail stocks, is flat this year. Retail stocks are far more volatile and, with the exception of a brief spurt up during Covid in 2021, have generally produced far lower returns than the broader market for years. The cheerleading section for a turnaround in retail is remarkably small. "Retail is likely going nowhere this year," one despondent longtime retail analyst told me. Not surprisingly, he asked to remain anonymous. The main issue: demand is muted because of the shift to services over goods. But it's more complicated than that. "The average consumer is showing some signs of stress," the analyst told me. "They are not over the effects of inflation, they got a poor tax refund, they are more worried about their employment than a year ago, their credit card balance is growing and their 401(k) is not doing great," he told me. The good news: profit margins may hold up better due to much lower inventory levels, and cost cutting will help improve an otherwise poor bottom line. Discounters are still the winners WalMart seems OK, thanks to strong demand for groceries and essentials, and upper income consumers who are "trading down," according to Dana Telsey at Telsey Advisory Group. That will help offset higher margin discretionary products like electronics that have been showing weakness for some time, Telsey says. Same with the off-price retailers like TJX, Burlington and Ross Stores. "Off-price indicators have appeared more resilient than broader retail," Mark Altschwager at Baird said in a recent note to clients. "Bigger picture, we like [the] risk/reward for the group, supported by high inventory availability, expense relief, easing comparisons and share- gain potential (as consumers seek value amid inflationary pressure)." Inventory levels are "normalizing," according to John Kernan at TD Cowen. That's good news, but "it could slow merchandise closeout opportunities for Off-Price retailers, [TJX and Ross Stores]," he says. What's hot in retail: running shoes & coconut water Looking at retail winners and losers this year, it is indeed hard to get excited about traditional retailing, with Big Lots, Gap, Macy's and Kohl's all down 20% or more. There's a small group of automotive retailers that are doing well, and people sure seem to be doing a lot of hiking and camping. Retail winners in 2023 Group 1 Automotive +23% Penske Automotive +22% Boot Barn +16% Camping World +16% Other than that, it's mostly about running shoes and coconut water. Running shoes are hot. There's a trend of smaller players capturing share from larger industry incumbents such as Nike and Adidas, according to Janine Stichter at BTIG. Case in point: Deckers (DECK) has a hot running shoe, Hoka. Deckers is up 23% YTD. Second case in point: On Holding (ONON), which makes the trendy ON running shoes, is up 94% YTD. It reported strong earnings this morning, with revenues up 78%. If that doesn't excite you, how about coconut water? Vita Coco (COCO) is up 75% YTD. The bottom line: it looks like the American public is eager to set up camp in the woods, go running and drink coconut water. Too early for retailers to guide down for the year While Home Depot did guide down, it might be a little more difficult for broader retailers to lower their forecasts for the full year this early. It has to do with the nature of retail, my despondent retail analyst friend tells me. "Retailers are largely dependent on fourth quarter sales," he tells me. "They do not like to give up on the year after three months. You can't tell your suppliers and employees in May, 'Hey we're going to miss the year, Christmas will be terrible.' You have to tell them, 'It's early, let's see what happens with back to school, we still have a chance to do OK.'"