Only the Strongest Retailers Will Survive in 2010 as U.S. Consumers Continue to Battle Back

The early returns on the 2009 holiday shopping season show a minor gain over last year's abysmal retail sales, and next year will affirm that retailers are successfully adapting to a consumer environment that's very different from years past.

However, 2010 will be difficult for retailers as they contend with high unemployment, tight credit, and aggressive competition.


Retail sales gained 3.6% year-on-year from Nov. 1 through Dec. 24, SpendingPulse, a unit of MasterCard Advisors (NYSE: MA) said earlier this week. But an extra day between Thanksgiving and Christmas this year may have skewed the data anywhere from 2% to 4%, SpendingPulse said. Sales in the same period last year declined 2.3% as consumers reeled from the financial meltdown that occurred in the fall.

"The latest holiday shopping season wasn't a rip-roaring success, but at least it met or slightly exceeded expectations," John Lonski, chief economist of Moody's Capital Markets Research Group (NYSE: MCO) told The Associated Press. "Consumer spending is indeed in a recovery mode, which brightens prospects for 2010."

Retailers last year resorted to fire sales in a desperate bid to unload excess inventory. But that won't be the case this time around, as most store managers erred on the side of caution in terms of orders. And in some cases, they may not even be able to meet demand.

"Retail sales so far appear to be up, which in of itself is a victory for retailers, given how horrible last holiday season was," National Retail Federation (NRF) spokesman Scott Krugman told CBS News. "They didn't have to resort to unplanned markdowns, which can only help the profit picture."

Online retailers, such as Inc. (Nasdaq: AMZN), fared even better than their brick and mortar counterparts, because they are not restricted by the display racks and checkout counters found in brick & mortar stores.

Amazon's growing scale and sophisticated inventory management system, which is used to leverage lower prices on some products, helped the company defy the sector's sagging sales last year, analysts said. Most retailers had to order products in the early fall, but online-only Amazon could have waited as late as November to place its orders - giving it a more accurate picture of what demand would be like.

Unfortunately for retailers, Christmas comes but once a year. And there are some steady headwinds that could make the wait for the 2010 holiday season a long one.

The Credit Crunch Continues

Retailers often use branded credit cards to close sales with customers who otherwise wouldn't be able to make a purchase at a given time. Although "frugality fatigue" will start to creep into the minds of some consumers, they still won't be able to return to pre-crisis levels of spending, as lenders like JPMorgan & Chase Co. (NYSE: JPM) tighten their belts in anticipation of a new law that goes into effect in February.

The coming law, dubbed the Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009 will ban the so-called "universal default," in which a consumer's interest rates are raised for missing a payment with another lender.

The NRF says the new law will threaten retailers' ability to grant instant credit at checkout. The NRF also criticized a proposal from the U.S. Federal Reserve that would require retailers to ask customers for information on income and other assets.

Twenty-two percent of consumers surveyed by America's Research Group had their applications for credit rejected in 2009, compared to just 12% in the previous year, Bloomberg News reported. More than 37% had their credit limits reduced in the past year.

The Fed's proposal would all but eliminate retailers' valuable closing tool - the branded credit card, NRF General Counsel Mallory Duncan says.

"It's going to have quite a chilling effect on our ability to initiate new accounts," Duncan told Bloomberg.

Still, analysts' estimates for sales and earnings next year remain positive for most of the big-name retailers: Wal-Mart Stores Inc. (NYSE: WMT) is expected to earn $3.96 per share on revenue of $433.93 billion and No. 2 retailer The Home Depot Inc. (NYSE: HD) will have an estimated earnings-per-share (EPS) of $1.70 on revenue of $66.20 billion in their fiscal years ending January 2011. That compares to an estimated EPS of $3.61 on revenue of $114.60 billion for Wal-Mart and $1.55 on sales of $65.35B for the current year ending next month.

Unemployment Will Weigh on Retail Growth

Any growth in the overall sector, as well as almost every other industry in the United States, also will be slowed by the nation's miserable unemployment rate, which is still at 10%.

The National Association for Business Economics (NABE) said in November that job declines will swing back to growth in the second quarter next year. Most analysts agree that's true, but that growth will be slow.

After the NABE survey results were published, minutes from the Fed's meeting last month revealed a slightly more optimistic picture for job creation by the end of 2010. The Fed's previous unemployment range of 9.5% to 9.8% was revised to 9.3% to 9.7%.

But longer term, the Fed isn't as optimistic about the future, as it expects the unemployment rate to hover between 6.8% and 7.5% in 2012.

Conversely, NABE expects the unemployment rate to return to a pre-recession level, which was 4.7% in November 2007.

The latest consumer confidence data from the Conference Board showed its second-straight gain in December, but there's still the underemployed - or the "real" unemployment rate of roughly 17% to consider. Those who can't work jobs that match their skill levels and subsequently aren't making the desired pay to match their lifestyles will be unable to make purchases beyond the necessities.

The Wal-Mart and Amazon Effect

Retail has always been competitive, but consumers' newfound frugality means there are less retailer dollars to be had - and competition has stiffened accordingly.

Wal-Mart put other companies on notice at the start of the holiday season, discounting several key items: It marked down more than 100 toys to $10 each, slashed prices on popular hardcover books by 60% or more, sold hotly anticipated DVDs for $10 and discounted the 25 most popular video games by 15% to 20%.

Competitors like Amazon and Target Corp. (NYSE: TGT) had no choice but to follow suit. When Wal-Mart revealed the video game discounts on Dec. 2, shares of the largest U.S. game retailer GameStop Corp. (NYSE: GME) tumbled more than 8%. Expect Wal-Mart to continue to set the tone for brick-and-mortar retailing in 2010.

Wal-Mart, the world's largest publicly traded company by revenue, is clearly the most influential player in the retail sector. However, Amazon, the venerable online retail force also has a say in the way all retailers - including Wal-Mart - conduct business.

In fact, Wal-Mart was forced implement its own online affiliate program that has an estimated $8 billion to $10 billion gross merchandise value (GMV) - about one-fourth of its total volume, according to a recent report from Janney Capital Markets.

Investing in Retail

Indeed, the pickings will be slim this year, but there's still room for growth in retail stocks.

The most room for growth is with online retailers as was demonstrated this past holiday season. The first returns on e-commerce sales are unanimously positive: SpendingPulse said sales grew 18% from Black Friday to Christmas Eve, while The Wall Street Journal reported sales grew 13.6%, citing data from research firm Coremetrics Inc.

Those looking for profits should consider these three retail stocks:

  • Amazon: Money Morning readers who bought this stock after a Feb. 5 "Buy, Sell, or Hold" recommendation have enjoyed about a 85% return. Though with a price-to-earnings (P/E) ratio of about 60, Amazon doesn't come cheap. Online sales account for just 7% of overall retail sales, according to Forrester Research Inc. (Nasdaq: FORR). That means there's plenty of room to grow as younger generations take to e-commerce Web sites for their purchases and older demographics continue to find more comfort with online shopping.
  • Wal-Mart: The House that Sam Built won't beat Amazon at its own game anytime soon, but's year-over-year growth of more than 20% is outpacing the rest of the industry, Vice Chairman Eduardo Castro-Wright said in the company's last quarterly conference call with analysts. The company's ability to absorb its ultra-thin e-commerce margins will increase its market share in the online space going forward. "We expect to continue to continue growing faster than the industry in the near future by maintaining price leadership," Janney Capital analyst David Strasser wrote in a recent report. Of course, Wal-Mart can still grow its brick-and-mortar business, particularly south of the border led by Wal Mart de Mexico SAB de CV (OTC ADR: WMMVY), which the retail giant owns a 31% stake in.
  • Home Depot: With the help of the Obama administration's first-time home buyer $8,000 tax credit, a surge of existing home sales in the United States has put the 2,000-store strong Home Depot in a prime position. With roughly half of those sales coming from first-time buyers according to the National Realtors Association (NAR), most do-it-yourselfers will find a Home Depot within miles for any supplies they need. Don't wait too long to move on this retailer: Since Money Morning's initial recommendation in our Dec. 3 Housing Outlook, Home Depot has gained almost 3%. While the tax credit extension lasts only until the end of April, but now includes a $6,500 credit for repeat buyers who have lived in the same home for five or more years.

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