In one of the most ironic twists and turns of the modern economic age, major retailers have profited enormously from the COVID-19 pandemic, a most stressful time that has encompassed months of continuous lockdowns, business closures and home living conditions in much of the country. followed by a slow and staggered return to normal life. What was a painful episode in many ways for millions of Americans has become an inadvertent boon for retail chains able to grow during the pandemic, and many have continued to enjoy improved prosperity even as COVID-induced lifestyle restrictions have mostly disappeared.
Prior to COVID-19, much of the U.S. retail industry struggled with consistently weak sales growth and modest or meager profitability as consumers expected deals galore and other perks (such as rewards programs and free shipping and returns) from retailers before they do. increase their spending. This dynamic tended to benefit larger general merchandise merchants, who could meet such demands, to the detriment of smaller chains. Over the past decade, the retail sector, especially specialty retailers, consistently topped the rankings for bankruptcy filings among industry sectors. But COVID-19 has changed all that, as huge financial relief for most households in 2020 and 2021, coupled with a shift in spending from services, such as travel and leisure, to consumer goods, have been extremely beneficial for most major retailers. Retail sales growth hit all-time highs from mid-2020 to early 2022, and operating margins have also increased. Large retail-related bankruptcy filings have fallen since COVID-19 hit and remain depressed more than two years later. All the while, there has been speculation about how long these good times will last for the retail sector. Lately, there is growing evidence that this period of unexpected prosperity may be fading.
First and foremost, inflation erodes nominal (i.e. non-inflation-adjusted) sales gains for most retailers. Nominal retail sales growth (YOY) has slowed in recent months, but this reduced growth would still be considered robust in any normal business environment. However, with inflation accelerating in 2022 and mid-to-high single-digit rates at the consumer and wholesale level, recent monthly sales gains are almost entirely inflation-related (Piece 1), which means that real (i.e. inflation-adjusted) sales growth for most retailers is modest or negligible, while operating margins are under pressure despite sales growth ratings still above average as operating costs are rising at a faster rate than most retailers would like or want. be able to pass on to customers. As a result, nominal monthly retail sales growth has become a somewhat misleading indicator of consumer spending activity. Increasingly, most shoppers are no longer buying merchandise these days; instead, they simply pay more for the same baskets of goods. High inflation hurts shoppers but does not benefit retailers, who themselves face rising costs across the board. Additionally, for expensive purchases that need to be financed, such as automobiles and furniture, the double whammy of higher sticker prices and rising financing rates is an affordability killer for most buyers, as evidenced by CarMax’s recent revenue loss and decline outlook.1
Perhaps the most troubling sign that the tide is turning against the retail sector is the pronounced inventory buildup that has developed in the sector in recent months. Inventory levels at the end of 2Q22 were significantly higher across all retail segments, increasing 31% (year-over-year) overall compared to 2Q21, with apparel retailers posting the largest increases (Piece 2). (It’s too early to tell if the high inventory levels were eliminated during the third quarter.) Some retailers were keen to say that stockpiling is deliberate and aimed at ensuring shelves are stocked at a time when Supply chain tensions have made product sourcing and on-time delivery more difficult and less reliable. That may be true in some cases, but we’re not buying it entirely; inventory builds at many retailers far exceed levels needed, based on current trends, to meet customer demand and are more likely to reflect excessive orders in a declining sales environment.2
Table 1 – Monthly nominal retail sales growth (YOY)
Source: US Census Bureau, Advanced Monthly Retail Report, August 2022
Additionally, America’s overstocking was a pervasive theme in US retail for years before COVID-19 and there’s no reason to believe this problem has abated since the pandemic, which which has made consumers more dependent on online shopping. Retail square footage per capita in the United States is a multiple of that of comparable countries, and has been for decades. Much of this is due to our country’s large size and widely dispersed population, but much of it is due to overbuilding. Remember the many conversations about “zombie malls” before 2020? Not much has really changed on the front. Eventually, the retail industry will resume its fundamental debate about why so many stores and malls are needed, as online sales continue to carve out the lion’s share of retail sales growth, while online market share exceeds 30% in several major product categories.
We are not suggesting that a rollback is underway for the retail sector. However, performance and operating metrics have peaked and are currently declining while still ahead of what they were in the pre-COVID era (Piece 3). It remains to be seen whether these measurements stabilize and remain above pre-COVID levels or eventually return to pre-pandemic readings. What is evident with greater certainty is that the outsized retail performance attributable to COVID-19 is declining, as seen in
With a recession in the United States looking more likely and the Federal Reserve giving every indication that it will continue to tighten monetary policy until inflation is brought under control, the domestic economy appears to be poised. to suffer, especially in the coming months when the effects of rising rates are felt before inflation recedes. Consumer spending momentum is weakening just as the retail sector enters the all-important holiday season. Amazon kicked off the season with a surprising second Prime Day promotional event in mid-October, the first time it has scheduled two separate Prime Day events in the same year. Not to be outdone, Target announced a similar week-dated promotion at Amazon’s Prime Day event. Such promotional events organized by these retail giants do more than advance the holiday season; they are siphoning off sales from other retailers that depend on the traditional holiday shopping season.
Exhibit 2 – Percentage increase in inventory (YOY)
Source: S&P Capital IQ analysis and FTI Consulting
Exhibit 3 – Return on investment
Source: S&P Capital IQ analysis and FTI Consulting
More importantly, most Americans are dealing with the combined effects of high inflation, rising interest rates and the wealth-losing effect of financial markets reeling as the season approaches. holidays – and they recognize that a difficult year is ahead for the American economy, recession or not. With financial markets back in bearish territory, no group – not even the wealthiest households relatively unaffected by inflation – can claim immunity from these economic headwinds. Unlike last year, far fewer Americans appear to be in the mood to splurge this upcoming holiday season, and the outlook for a continued COVID-focused retail stimulus appears to be weakening. Over the month.
Overall, the retail industry is on stronger footing than it was in 2019, but those who made critical business decisions or strategic investments on the assumption that performance trends induced pandemic would persist indefinitely expect a rude awakening next year.
2: Forbes, retail inventory glut is about to get ugly, October 7, 2022
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