When execs at two giant retailers field questions from major investors at a conference, I tend to listen to the live webcasts or pay extra attention while sitting in the audience. Might want to carve out a few minutes and give it a try sometime.
Execs at Macy's (M) and Abercrombie & Fitch (ANF) offered valuable clues into the state of the U.S. consumer on Tuesday morning. Interestingly, what both companies said was rather downbeat. In fact, it actually confirmed the Fed's more tempered view on economic conditions in the U.S., while at the same time questioning the need to raise interest rates this summer.
The overall takeaway is that years after the Great Recession ended, in spite of the jobs recovery and improvement in personal wealth for many, there remains a psychological impediment to spending more on services and discretionary merchandise. It's very fascinating to see this continuing to play out, but also makes one wonder if equity valuations on consumer discretionary stocks, right on down to the truckers who ship their goods, are stretched.
Macy's Is Still Competing for Consumer Wallets
Shopping at Macy's is an affordable luxury. If one wants a name brand workout shirt at 25% off, they go to Macy's. A Michael Kors (KORS) watch? Probably Macy's as opposed to the Michael Kors retail stores. However, even in the face of Macy's affordability factor and the higher-income consumer it attracts, the company continues to battle service companies for discretionary dollars.
On Tuesday, Macy's CFO pointed out that consumers are still favoring ordering a monthly service like Netflix (NFLX) instead of buying an article of clothing. Compound that with the inevitable monthly Apple (AAPL) App Store purchases and iPad monthly data service, it becomes clear that stagnant incomes have a downside -- they limit where households allocate their more frivolous spending decisions.
For this to change, as in consumers plunking down money for Netflix and two pairs of Levi's in any given month, there has to be quicker wage growth in this country. But we're unsure when that will begin to surface, which certainly raises the prospect of some subpar earnings reports from consumer companies in the quarters leading up to the peak holiday season.
Abercrombie Opens the Floodgates for Going Out of Business
Yes, you read that correctly. For the first time, many on Wall Street I talk with are concerned about Abercrombie surviving to see the year 2025. That concern is a byproduct of one thing execs are doing today -- lowering prices aggressively overseas, where fixed and variable costs remain high, and here in the U.S.
In part, the explanation for the price-lowering campaigns is a result of consumers not putting a high degree of value in spending discretionary dollars on overpriced Abercrombie T-shirts and jeans. The other is due to the ongoing opening of fast fashion retailers such as H&M, Zara and Forever 21. An Abercrombie & Fitch exec mentioned on Tuesday it will now be rolling out lower prices at all of its U.K. Hollister stores. Previously, there was only a test at 11 stores. Price cuts, going back to older comments from former CEO Mike Jeffries, may be close to 15%.
Until now, Abercrombie & Fitch has been able to offset its lower average unit retail prices by re-engineering products, or what it calls bringing down average unit costs. But there is only so much of that to be done, and over time the company's lack of pricing power in a dynamic market will likely crush margins, cash flow, the stock and its ability to stay in business.
How to Play Taco Bell's Breakfast Intentions
Taco Bell (YUM) wants to own the breakfast category in the fast-food industry -- it's something I felt for quite some time from listening to execs (mostly longtime leader David Novak). The fast-food chain's latest social-media favorite, a breakfast biscuit, is likely to coincide with the rollout of a series of healthier breakfast introductions this year (think Greek yogurt).
I think Taco Bell's strong, consistent breakfast innovation is bad news for McDonald's (MCD), which depends on breakfast for more than 20% of its sales. Breakfast sales for McDonald's have been positive for a nice stretch of months even as the rest of the menu has fallen out of favor. I would be thinking about a change in the upbeat trend for the Golden Arches by later this year due to Taco Bell's inroads into the morning service hours.
I would be looking to make a wager against McDonald's shares here.
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