Traders report this week.
Here’s the good news: the consumer is strong and retail balance sheets have improved dramatically.
“I’ve been optimistic for over a year,” said David Berman, portfolio manager at Durban Capital. “There is a lot of money for the consumer, there are a lot of jobs and the demand is high. Retailers are healthier because the number of stores is decreasing, so the environment is more rational.”
And what about supply chain problems? “Retailers have pricing power and are able to pass on the higher labor and raw material costs so gross margins should stay strong, just like they did with Home Depot,” said Berman.
Here’s the bad news: For some retailers, much of the earnings growth over the past decade has resulted from becoming “buyback monsters” who aggressively buy back stocks.
Retailer: buyback monster?
(Reduction of the number of shares, since 2011)
- Dillards 64%
- Cabbage 51%
- Gap 38%
- Home deposit 35%
- Target 31%
- Ross Stores 25%
- TJX 24%
- Walmart 22%
Source: fact set
The upshot: Over the years, reducing the number of stocks has made retail profits look stronger because there are fewer stocks in circulation. In many cases, sales growth has been modest or nonexistent.
Kohl’s, for example, will have the same sales as 2016, but the result is much stronger. Dillard’s will have the same sales this year as 2018, but earnings are also significantly higher.
How does it work? Partly by working more efficiently so that more profits flow into the end result, but also partly by means of constant buybacks.
Joe Feldman, Senior Managing Director of Telsey Group, notes that retailers give shareholders what they want.
“The investment community likes to see buybacks because it makes their stocks more valuable,” he told me. “It makes trends better than they otherwise would be.”
Covid suspended buybacks but has since resumed
Many retailers, including Target, Kohl’s, and TJX, suspended buybacks during the pandemic but have since returned to buying stocks. TJX, for example, bought back $ 300 million of shares in the second quarter, which was the first buyback since the first quarter of 2021.
Kohl’s repurchased shares every quarter from the first quarter of 2010 through the first quarter of 2020, then suspended repurchases for the remainder of 2020 and resumed in the first quarter of 2021, according to Ben Silverman, director of research at InsiderScore.
Should companies buy back shares as cash flow rises?
“I’m not a big fan of share buybacks,” Berman from Durban told me. “I would prefer them to increase their dividends.”
Telsey’s Feldman rejects the notion that retailers ignore investments in their stores in favor of buybacks.
“The better quality companies invest heavily in digital infrastructure and in the supply chain,” he said. “Walmart is spending $ 13 billion on investments this year. But there is only so much you can do. These companies make so much money that buybacks are a way to give back to shareholders.”
Black Friday discounts?
One thing is for sure, when the consumer is overflowing with cash and short stocks, don’t look for “half” sales on Black Friday.
“There may be some modest sales, but you won’t see massive promotions like you did a few years ago,” Feldman said.
This is good news for retailers, but consumers may need to get used to a sticker shock.
“There are many full-price sales that make up for the higher cost,” Feldman said. “You still want some incentive to get people into stores, but right now it’s mostly full price.”
What is to be feared?
Not all glass is half full.
Investors will pay close attention to an update on inventory levels. Nobody wants to be caught with high demand and no supply over the holidays.
There are also concerns about waning consumer incentives, which could be a heavy source of spending in the first quarter.
The big problem, however, is the steadily rising prices that put profit margins at risk.
“At some point, when it comes to higher prices, you can only get so much through before the consumer pushes back,” Feldman said.
“It hasn’t happened yet, but it will if prices keep rising.”
Disclosure
The Telsey Advisory Group (TAG) has no interests in any of the securities covered by the TAG. No TAG research analyst holds any stocks of securities that are covered by the analyst.
TAG research analysts do not receive any remuneration from the companies concerned. TAG provides investment banking and other non-investment banking securities services, as well as non-securities services, and may seek such relationships from companies through which it offers research. TAG, its employees and their households have no other conflicts or potential conflicts of interest.
