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  • Retail sales are slipping as cash-strapped consumers buckle down on spending.
  • Walmart, Target, and Home Depot results are proxies for what may be ahead for the holidays.
  • Stocks targeting bargain-hunters may benefit most this year.

Retailers could be in for a Grinch-like holiday season this year based on recent comments from key companies, including Walmart  (WMT) , Target Corporation  (TGT) , and Home Depot  (HD) .

The industry is increasingly relying upon price hikes to drive growth, rather than unit volume, and strength in essentials, such as food, rather than higher-margin discretionary purchases, such as electronics.

In its earnings report, Home Depot acknowledged that higher prices meant better-than-expected revenue and profit growth. Comparable sales improved by 4.3%, but customer transactions declined by 4.3% from one year ago. The increase was entirely due to an 8.8% increase in the average ticket price, likely driven by inflationary price increases to protect margins.

The lackluster transaction volume isn’t too surprising, given soaring mortgage and equity loan rates have caused home sales to collapse and a slowing in renovations. The risk of declining demand prompted Raymond James analyst Bobby Griffin to express concern “transactions could remain negative in 2023,” causing him to downgrade Home Depot stock to market perform from outperform. Griffin has a 5-star rating from TipRanks.

Target’s results were arguably more concerning because, unlike Home Depot, the company couldn’t exceed forecasts, including its internal outlook, despite higher prices.

Last quarter, Target’s earnings per share tumbled 49% year-over-year because of declining operating margins. The operating margin was just 3.9% in the quarter, far below the 6% suggested for the second half of its fiscal year and even farther below the 8% plus delivered in 2021.

The results prompted Real Money’s Stephen Guilfoyle to write

“Target Corp (TGT) released its third quarter financial results on Wednesday morning, and for the third time in a row, the retail chain put together a lousy quarter…It's difficult to see a reason for optimism in much of this. The execution has been poor. Inventory management has been poor. The firm's guidance has been way off and is poor. Margins are way down. Cash on hand has dwindled. Free cash flow has gone from decisively positive to decisively negative. Do I need to go on?”

Action Alerts PLUS Co-Portfolio Managers Bob Lang and Chris Versace didn’t find much for shareholders to cheer about Target’s stock. They wrote: 

“Target's comp sales rose 2.7% during the quarter, modestly ahead of the 2.5% consensus, but those sales were fueled by Beauty, Food and Beverage, and Household Essentials, which offset continued softness in discretionary categories…Target also warned that softening sales and profit trends that emerged late in its October quarter have persisted into November. This led the company to forecast a surprise drop in holiday quarter sales due to inflation and "dramatic changes" in consumer spending, raising questions over discretionary spending.”

Target’s guidance for negative single-digit comparable sales growth this quarter – a historically strong quarter because of holiday shopping - is discomforting.

Walmart’s results compare favorably to Target, but extrapolating management’s comments to the broader retail industry isn’t encouraging.

Walmart’s U.S. comparable store sales growth, excluding volatile gasoline sales, was 8.2%. Transactions were higher, up 2.1%, but like Home Depot, average ticket size did the heavy lifting, up 6%. The company reported strong results in grocery and health and wellness but a concerning low single-digit drop in general merchandise categories, including electronics, home goods, and apparel, which are margin-friendly categories.

Management said on the company’s conference call:

“General merchandise sales declined low single digits with softness in electronics, home, and apparel...Inflation remained high, up mid-teens percentage in food categories…Food sales continued to lead with mid-teens growth…We observed incremental trade down in categories, including proteins, baking goods, baby, and dog food….High fuel prices and mid-teens food inflation have forced consumers to manage household budgets more tightly, making frequent trade-offs and biasing spending toward everyday essentials…Regardless of income levels, families are more price-conscious now.”

The shifting shopping trends from discretionary to essentials has Walmart expecting a sequential dip in comparable sales growth this holiday quarter to 3% and earnings ‘growth’ of negative 3% to 5%. So, despite Walmart stock performing well following this report, this is still a pretty discouraging outlook for those hoping retail stocks will enjoy a festive holiday shopping season.

Overall, the downbeat outlook for retail sales reflects consumers under considerable strain.

Wages have been trailing multi-decade-high inflation since early 2021. As a result, the personal savings rate has declined to its lowest level since 2007, while consumers’ revolving debt (credit cards) has skyrocketed to record levels. Given rates are likely still heading higher, increasing interest rates on credit card debt, pressure on consumers’ budgets isn’t likely easing. According to Bankrate, the average interest rate on credit cards has climbed to 19.14%, the highest since the company began tracking the data in 1985.

The risk to consumers prompted Action Alerts’ PLUS co-Portfolio Manager Chris Versace to say this week, “We got some quarterly updates on household debt levels from the Federal Reserve. And man, oh man, did they shoot up considerably during the third quarter. And when we step back, we know that interest rates continue to move higher. They're going to move even higher than where they are. We take a look at the inflation that we're seeing, you have to question how much longer can this go on, especially as the number of layoffs continues to rise.”

The Smart Play

The National Retail Federation says November and December historically represent about 19% of retailers' annual revenue, so a downturn this year could mean retailers report disappointing sales figures. That could be bad news for year-over-year earnings growth because sales last year were so strong. According to NRF, holiday season spending grew 13.5% last year but will only grow less than 8% this year. As a result, year-over-year comparisons create a tough hurdle for retailers.

A big question is how much of this weakness is priced into stocks already. This week, Walmart rallied, while Target fell sharply after reporting results. Perhaps, that suggests retailers most associated with discount prices will do better than others this season. If so, dollar stores and warehouse clubs could perform better as consumers shift spending to them from pricier competitors. 

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