Peak Promotions

For most of the current profit cycle, the retail industry has been burdened by overcapacity and unsettling ecommerce trends. As a result, the environment for many consumer companies has been challenging and highly promotional.

While deep discounting remains popular, not everyone has conformed to the promotional norms. In fact, based on recent earnings results and commentary, the reliance on promotions appears to be receding, while the emphasis on “full-price” sales is gaining momentum.

Two Bloomberg articles recently touched on this subject. The first article, “Clothing Retailers Are Finally Catching Some Breaks” highlights the improving same-store sales of apparel companies. While several reasons were noted, the following comment from Bloomberg’s apparel analyst caught my attention.

“The improvement likely suggests clothing retailers lately have done a better job selling full-price goods, relying less on promotions and discounts.” [my emphasis]

While the full-price model isn’t new, I believe more businesses are considering and in some cases transitioning. Ralph Lauren (RL) is the first company that comes to mind when I think of companies choosing profits over promotions. Stein Mart (SMRT), my favorite apparel retailer (for shopping, not investing), is another good example.

In March, Stein Mart reported a significant improvement in earnings, causing its stock to spike 68%! Although Stein Mart’s same-store sales remained negative, operating income rose sharply due to a 380 basis point increase in gross margins. The quarterly improvement was driven by lower inventories, fewer promotions, and “significantly increased regular price selling”.

Stein Mart’s transition from relying on promotions to improving profitability wasn’t easy. From Stein Mart’s conference call:

“As you can see from our 2017 results however, transitioning to lower and healthier inventories can have a short-term impact on sales and margins. Through the third quarter of 2017 margins were hurt by additional markdowns to clear excess inventory.”

However, its transition is finally paying dividends…

“This better mix of more regular price sales and less clearance in the quarter as well as higher mark ups resulted in an overall better margin.”

…with higher margin trends continuing.

“Our sales are now much more profitable with the lower clearance level. Our current regular price selling results are strong.”

And finally, management provided an optimistic assessment of current sales trends.

“For the month of February with spring selling underway, our sale trends have improved dramatically compared to last year driven by higher regular price selling offset by lower clearance selling.”

While competition remains fierce, pricing pressure may also be stabilizing in other areas of retail. During Dick’s Sporting Goods (DKS) most recent conference call, management stated they hope to receive “full margin” on newly released innovative products. Furthermore, as it relates to promotions and the competitive environment, management implied stability.

“But as far as getting deeper discounts or deeper into a new price battle, we don’t see that right now. But that’s as of today that can always change tomorrow.”

[Side note: I’ve recently received an unusually high number of promotional emails from DKS. The last time I noticed this, they had a poor quarter!]

Another consumer company, Darden Restaurants (DRI), also discussed the current promotional environment and the possibility of changing trends. Below are management’s comments related to the industry’s rising check average.

“But, the real change that we’re seeing…is that the check average appears to be growing and has picked up some steam. And as we look at that, we’re trying to analyze whether that is the industry taking more pricing, is it a pullback on some discounting, is it change in promotional strategy?

Highly promotional trends may also be subsiding in other sectors of the economy, such as durable goods. A recent Bloomberg article, “Americans Urge to Splurge Making Inflation Hawks Edgy” analyzed the University of Michigan’s latest survey of consumer sentiment. The survey indicated shoppers of durable goods are anticipating lower promotions and higher prices.

“More American consumers than at any time in 27 years are convinced that it’s better to make big purchases now because retailer discounts and deals won’t be around much longer.

The director of the survey, Richard Curtin, made the following comments.

“When asked about buying conditions, the appeal of low prices has largely disappeared. For durables, it has been replaced by favoring buying in advance of anticipated price increases.

Excluding companies that are not required to generate an adequate return on capital (wink, wink, you know who you are 🙂 ), the path to prosperity is rarely filled with deep discounting and price wars. As such, it’s rational to assume the number of companies exiting the promotional mud pit — dead or alive — will continue to increase.

In my opinion, increasing wages, along with elevated store closures and bankruptcies, should benefit surviving businesses attempting to kick their deep discounting habits. Assuming more companies follow the less promotional path, it will be interesting to learn how sales, margins, and consumer prices respond. As Q1 earnings roll in, peak promotions is one of many trends I plan to monitor and analyze.

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With earnings season picking up steam, I may be unable to post for the next 2-3 weeks. Good luck to those who remain in equities. And for those patiently investing in cash, t-bills, and short-term Treasuries, yields are becoming more and more interesting! Yesterday the 12-month Treasury hit 2.15%, with the 2-year USTN yield reaching 2.43%. It remains a great time to check those cash balances and make sure you’re not getting short-changed by a bank or money market fund.

Sometimes I feel like the only person excited about higher short-term rates. I attended a social event last weekend and no one, I mean no one, was talking about the sharp run-up in short-term yields. They should be. Just look at the 2-year yield chart — it’s beginning to look more impressive than most FANG stocks! Now at 2.43%, the 2-year was only yielding 0.75% a couple years ago. It’s been a huge move (link to 2yr chart).

Hopefully short-term rates continue to march higher, rewarding patient investors with either higher income or an abrupt end to the current market cycle (lower equity prices).

I hope everyone has a wonderful earnings season! I’ll be back in a few weeks.

transcript source: Seeking Alpha