August 8, 2019

Trade Wars Weighing on U.S. Retail Earnings

by Jharonne Martis.

Retail analysts polled by Refinitiv are cautious about Q2 earnings expectations, especially since many retailers lowered their earnings guidance for Q2. The Q2 2019 retail blended earnings growth estimate is 1.8% — a sharp contrast with Q1 2019, which saw an 8.3% growth in retail earnings.

Let’s dig in and look at the major factors:

  • The latest reading of American consumer confidence, as measured by the Refinitiv/Ipsos Primary Consumer Sentiment Index suggests consumers still have some ongoing concerns surrounding job security and possible repercussions on local economies.
  • Most U.S. retailers are concerned about the higher costs associated with tariffs imposed on China.
  • This year alone, retailers have discussed Chinese tariffs in 138 earnings calls — and that might just be the beginning.
  • If tariffs are imposed on China, this will have a dual effect on both countries:
    • Fathom Consulting data suggest the growth slowdown in China might be worse than reported by its government.
    • If China strikes back and restricts the supply of minerals to the U.S., several American mobile phone makers could be affected including Apple, T-Mobile, and Microsoft, according to ChinaScope data.
  • For Q2 2019, there have been 49 retail negative EPS pre-announcements, compared to nine positives. The bulk of this negative guidance is coming from the apparel retailers – a sector hit with higher tariffs.
  • As a result, the Refinitiv Retail and Restaurant Q2 earnings index is expected to show a rise of only 1.8%.
  • The Household Products sector shows robust earnings growth rate of 11.1%.
  • The Textiles, Apparel & Luxury Goods sector has the lowest growth rate (-6.6%) of any sector.
  • Retailers are facing very tough comparisons from a year ago, when consumer spending was robust and posted its strongest quarter in 2018.
  • The Refinitiv Retail Same Store Sales Index is looking at a 2.2% Q2 2019 growth, below the 4.9% SSS result posted last year.
  • Under the Specialty sector, the beauty supply group is on track to post the strongest result with a 4.0% SSS growth, above last year’s 2.9% SSS result.
  • On the flip side, many apparel stores are expected to post negative SSS.
  • The restaurant sector has stronger SSS estimates than the retailers. This might suggest that consumers went out more for dining experiences rather than shopping,
  • The Refinitiv Restaurant Same Store Sales Index is looking at a robust 3.5% Q2 2019 growth, above the 1.8% SSS result posted last year. All sectors are performing stronger than a year ago.

Q2 2019 Earnings Growth

The Refinitiv Retail and Restaurant Q2 earnings index is expected to rise 1.8%. When looking at the earnings growth rates for Q2 for the 210 retailers tracked by Refinitiv, the Leisure Products sector, followed by the Household Products sector have the highest earnings growth rate at 58.8% and 11.1%, respectively. On the flip side, the Textiles, Apparel & Luxury Goods group has the weakest anticipated growth compared to Q2 2018.

The Leisure group earnings growth rate is being affected by Mattel’s negative result. Although, it’s an improvement from the previous year, the result is still negative. Mattel has the biggest weighting in the sector, that if it is excluded from the group, the earnings growth rate drops from 58.8% to -5.7%. Four of the six retailers in this group have negative earnings growth rates.

Seven of the nine retailers in the Household Products sector already posted higher earnings compared to a year ago. Clorox Co. (19.0%) and Procter & Gamble Co. (17.0%) have the highest earnings growth results. Meanwhile, Eberguzer Holdings Inc. (-15.3%) has the weakest EPS growth estimate in the sector.

Five of the eleven sectors are expected to see negative growth this quarter. The Textiles, Apparel & Luxury Goods sector has the worst negative growth rate (-6.6%). Nine of the twenty one retailers in the sector are expected to see Q2 earnings declines, led GIII-Apparel Group  which already posted earnings (-132.1%).

Exhibit 1: The Refinitiv Retail Earnings Growth Rate – Q2 2019

Source: I/B/E/S data from Refinitiv

Trade Wars – Chinese Tariffs

This year alone, retailers have discussed Chinese tariffs in 138 earnings calls, and that might just be the beginning. President Trump says the U.S. will impose 10% tariffs on $300 billion worth of Chinese goods, including apparel and footwear. These are expected to be imposed as early as September 1.

This announcement is weighing on retail stocks globally and continues to fuel a trade war between the China and the U.S. If tariffs are imposed on China, this will have an effect on both countries. China’s economic growth rate fell to 6.2% in Q2, its lowest reading since the early 1990s. Fathom Consulting’s indicator of China’s economic growth – the CMI – has now fallen for three consecutive months, to 4.8% in May, suggesting that growth has been worse than that.

Exhibit 2: Fathom China Momentum Indicator 2.0 and GDP

Source: Refinitiv Datastream/Fathom Consulting

Possible Retaliation

China has control over rare earth metals, which are much needed in the global tech industry. There’s been talk about China restricting the supply of these minerals to the U.S. The ChinaScope data below highlights how rare earths are used in such key devices as cell phones. The American companies that could be affected by this include Apple, T-Mobile, Telephone and Data Systems, Microsoft and Blackberry among others.

Exhibit 3: Mobile Phones (Down Stream from Touch Screen Display)

Source: ChinaScope data, available on BattleFin Ensemble Platform

Still, most retailers in the U.S. are concerned about the higher costs associated with the tariffs. Since most apparel bought in the U.S. is made abroad (mostly in Asia), the trade war will make buying clothes in the U.S. more expensive. When looking at our earnings guidance data, the Apparel sector has the most negative guidance. U.S. customers can’t just switch to an American manufacturer – there simply aren’t many of those around anymore. So higher-cost imports will either hurt retailers’ margins, or if they pass the costs onto consumers, cut into demand.

Consumer Confidence

American consumer confidence, as measured by the Refinitiv/Ipsos Primary Consumer Sentiment Index, is 62.5 for July 2019. The national index is flat, just a 0.3 point decrease since last month, but is up 0.9 of a point since the beginning of the year. The PCSI sub-indices show mixed signals with decreases in this month marked by two of the four indices: Current and Investment – which observed significant declines. The Expectations index is flat, and the only index with improvements this month was the Jobs Index.

“While the unemployment rate continues to hold at a 50-year low, consumers still have  some ongoing concerns surrounding job security and the possible repercussions on local economies,” reports Chris Jackson of Ipsos. “Consumers appear to be currently enjoying the benefits of low unemployment; however, they also seem to be cautious as they look into the future and what this may mean for their personal financial situation.”

Analysts polled by Refinitiv are also cautions about Q2 earnings expectations, especially since many retailers lowered their earnings guidance for Q2. For Q1 2019, retailers posted an 8.3% growth in earnings. This is expected to drop to an estimated earnings growth rate of 1.8% for Q2 2019.

Exhibit 4: Consumer Confidence As Measured By Refinitiv/Ipsos PCSI

Source: Eikon

Guidance

In the Refinitiv Retail and Restaurant Earnings Index, there have been 49 negative EPS pre-announcements issued by companies for Q2 2019 compared to nine positive EPS pre-announcements. Similarly, there have been 35 negative revenue pre-announcements issued by corporations for Q2 2019 compared to 23 positive revenue pre-announcements. The bulk of the negative guidance is coming from the apparel retailers. The same trend is surfacing for Q3 2019.

Exhibit 5: Earnings And Revenue Guidance: Q2 and Q3 2019 Outlook: Refinitiv Same Store Sales Index

Source: I/B/E/S data from Refinitiv

Retailers are facing very tough comparisons from a year ago, when consumer spending was robust and posted its strongest quarter in 2018. The Refinitiv SSS index is expected to see 2.2% growth in Q2 2019. A 3.0% SSS reflects healthy consumer spending. The 2.2% SSS estimate is considerably below the 4.9% result seen in Q2 2018.

However, there are a number of sectors expected to post stronger results this time around. Under the Specialty sector, the beauty supply group is on track to post a 4.0% SSS growth, above last year’s 2.9% SSS result. On the flip side, the department store sector is facing difficult comparisons from a year ago at 0.8% SSS, and is expected to post a -1.0% SSS this time. The group is on track to post its second consecutive quarter of negative comps. Still, the discount sector continues to post healthy comps with a 2.7% SSS estimate, below last year’s 5.6 SSS.

Meanwhile, many apparel stores are expected to post negative SSS, and as a result the group is expected to post a 1.3% SSS, below last year’s 4.0% SSS

Exhibit 6: Refinitiv Same Store Sales Index

Source: I/B/E/S data from Refinitiv

Same Store Sales Top Estimates/Results

The Lovesac company, dubbed the “world’s most adaptable couch,” has the strongest SSS estimate in our retail universe with a 27.5% SSS comp. It continues to benefit from the housing industry. In apparel, Lululemon is on top benefiting from the hot athleisure trend, with an 11.6% SSS estimate. Meanwhile, consumers are buying apparel at Aritzia, which already beat its 7.4% SSS estimate with a 7.9% SSS result. American Eagle is also receiving a boost from Aerie’s 16.8% comp. Ulta Salon continues to be a favorite among millennials and has a 6.7% SSS estimate. Meanwhile, Costco is on top among the discounters and already reported a 5.5% result, above its 4.8% SSS estimate.

Exhibit 7: Top Same Store Sales Estimates – Q2 2019

Source: I/B/E/S data from Refinitiv 

Same Store Sales Weakest Estimates/Results

Pier One already missed its -10.0% SSS estimate, and posted a -13.5% SSS result. JC Penney continues to have the weakest SSS estimate among the department stores at -4.9%, and is haunted by severe debt. The department store has the lowest score of 1 on the StarMine Combined Credit Risk Model, the most comprehensive StarMine credit model. According to StarMine there’s a high probability of credit default. Meanwhile, mall stores have been out of favor, and continue to hurt from weak store traffic. These weak performing mall stores include Kirkland’s, Express, Children’s Place and the Ascena Retail Group, with comp estimates of -7.5%, -6.7%, -3.8% and -3.3%, respectively.

Exhibit 8: Bottom Same Store Sales Estimates – Q2 2019

Source: I/B/E/S data from Refinitiv

Refinitiv Restaurant Same Store Sales

The restaurant sector has stronger SSS estimates than the retailers. This might suggest that consumers went out more for dining experiences rather than shopping, as consumer preferences continue to shift.

The Refinitiv Restaurant Same Store Sales Index is looking at a robust 3.5% Q2 2019 growth, above the 1.8% SSS result posted last year. All sectors are performing more strongly than a year ago. The quick service sector and casual dining sectors have stronger comp estimates vs. last year’s 1.9%, and 1.6% SSS results. The fine dining has the weakest SSS estimate among the sectors at 0.9%, but stronger than last year’s 0.5% SSS.

Exhibit 9: Restaurant Same Store Sales Sectors – Q2 2019 VS. Q2 2018

Source: I/B/E/S data from Refinitiv

Restaurant Same Store Sales Winners

Chipotle already beat its 7.3% SSS, with an outstanding 9.9% result. The restaurant has now posted four consecutive quarters of improving robust comps as digital sales double. Meanwhile, Texas Roadhouse reported a 4.7% comp, above its 4.4% SSS estimate. The same can be said for Domino’s Pizza, which reported a 3.0% SSS result, below its 4.8% SSS estimate. Meanwhile, Diversified Restaurant Holdings is on track to report a 5.0% SSS estimate.

Exhibit 10: Top Restaurant Same Store Sales Estimates – Q2 2019

Source: I/B/E/S data from Refinitiv

Restaurant Same Store Sales Losers

Only four out of the 36 restaurants in our index have negative SSS estimates. Papa John’s International has been one of the weakest performers for some time now. For Q2 2019, Papa John’s continues to have the weakest SSS estimate of  -5.7%. Still, this estimate is an improvement from the previous quarter as the restaurant continues to introduce new offerings. Likewise, Potbelly Corp. is now on track to post ten consecutive quarters of negative SSS and has a comp estimate of -3.0%, followed by Red Robin Gourmet Burgers at -1.4% SSS estimate.

Exhibit 11: Bottom Restaurant Same Store Sales Estimates – Q2 2019

Source: I/B/E/S data from Refinitiv

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