Markets & Finance

Second-Half Outlook: Retail


Americans went on a shopping spree in the first half of the year, apparently unfazed by higher gas prices. That has helped boost sales at retailers ranging from Macy's of Federated Department Stores (FD) to warehouse discounter Costco (COST) until May.

But dark clouds are looming as rates rise and the housing market cools, it doesn't seem the spree can last forever. "Consumers have shown immense strength, but I worry if there is a tipping point in the second half of the year," says Michael Niemira, chief economist and director of research at the International Council of Shopping Centers in New York.

The tipping point that Niemira is referring to was inflation and higher interest rates. The Federal Reserve is worried about inflation, which led it to raise rates by 25 basis points this week. According to the Labor Dept., consumer prices increased by 0.4%, and the core consumer-price index, which excludes food and energy items, grew 0.3% in May, the third straight rise of that magnitude. Even though consumers haven't shown signs of worry, higher prices at some point will put a dent in their wallets. And retailers, who have taken advantage of lower rates, won't find it so easy to offer 0% short-term loans to their shoppers either.

OBVIOUSLY EDGY. On the high end, Coach (COH) bags continue to fly off shelves, and luxury retailer Neiman Marcus continues to lure women keen to buy the latest Manolo Blahnik shoes. Movado Group (MOV), which makes high-end watches that retail for as much as $25,000, beat Wall Street's forecasts for the first quarter, when its sales rose 11.4%, to $97.7 million. CEO Effraim Grinberg recently said at a retail summit: "Obviously we're in a market that is in a lot of flux in terms of stock markets and energy, but the consumer has reacted well now for a number of years through that."

Even though its stock has risen 19% so far this year, the company's management is positive about its future performance. "We believe our company will continue to grow this year," said Grinberg.

With the housing slowdown, everyone is skittish about the performance of companies like Home Depot (HD), Lowe's (LOW), and Bed, Bath & Beyond (BBBY). Recently shares of these companies have struggled. Home Depot's stock has tumbled 10%, Lowe's has fallen 6%, and Bed, Bath & Beyond shares dropped to a 52-week low, after the company reduced its quarterly earnings outlook.

Lowe's Chief Executive Robert Niblock says that the housing slowdown will likely be limited only to about 20 markets in the U.S, that have seen a bubble in housing prices, like Miami, San Diego, and Santa Barbara, Calif. However, he's not worried about the impact on Lowe's because of the strength of the economy in these pockets. "The top 20 markets are solid employment markets and higher-income markets," says Niblock. Still, investors will find it hard to invest in companies that are so directly tied to the housing cooldown.

"TOO CHEAP?"Discounters have done well and are obviously edgy about a potential slowdown in the economy. The first kind of consumers hurt by a downturn are lower-income shoppers. So Family Dollar (FDO) and Dollar Tree (DLTR) will likely feel the pain of consumers holding back.

But both large discounters Wal-Mart Stores (WMT) and Target (TGT) could be poised for a rebound. Merrill Lynch analyst Stacy Turnof says money managers who invest in large-cap stocks have been increasing their holdings in these companies' stocks.

Target has seen its stock beaten down a little because of reduced sales in its furniture aisles and lower margins, but Goldman Sachs retail analyst Adrianne Shapira says: "Target's stock is too cheap." As for Wal-Mart, its focus on margins and customers heartens Wall Street. Says Shapira of Wal-Mart: "This turnaround has legs."

Editor's Note: An early version of "Second Half Outlook: Retail" appearing on BusinessWeek.com the morning of July 5, 2006, contained an incorrect stock symbol for Federated Department Stores. The correct symbol is FD, not FED (the symbol for FirstFed Financial Corp., which was not the subject of our story).

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