How the Recession’s Hitting the Retail Sector

by George Leong, B. Comm.

For the past year, I have been warning readers about the risk of investing in retail stocks given the declining consumer confidence, rising job losses, lost value in stocks, and the weak housing market, which has negatively impacted household wealth and created a poverty effect. The decline in total household wealth along with a rise in the savings area is creating a situation where consumers are thinking hard about spending on unnecessary goods and services. This could be everyday items that you may have taken for granted, such as going out to restaurants, seeing movies on the big screen, buying new clothes, or even buying a newspaper. Consumers are also refraining from buying big-ticket items such as cars, appliances, and major electronic goods.

Here we are in April with the spring season upon us and guess what? Shoppers remain tepid and are staying away from purchasing non-essential goods. The reality is that consumers are not lining up at the malls waiting to buy goods. Given the decline in overall material wealth, we are clearly continuing to see a decline in consumer spending.

Data just came out that showed retailers struggling to attract shoppers in March. Retail sales excluding auto fell 0.9% in March, compared to the expected 0.0% estimate. This is down from 1.0% in February.

The focus remains with buying essentials and those goods necessary to survive. Instead, shoppers are heading to the discounters and wholesale clubs to economize money.

We are seeing the discount retailers doing well, while those that sell luxury and big-ticket items are seeing major sales declines. Case in point: electronic giant Circuit City is now gone. There are numerous retailers struggling with debt payments and burgeoning inventory levels. To deal with this, retailers have to initiate major discounting to rid themselves of inventory and this impacts margins and bottom-line profits. In fact, consumers continue to show signs of expecting further price declines before buying. A trend of price declines increases the threat of deflation, which is bad for companies.

Companies like Costco Wholesale Corporation (NASDAQ/COST) and Wal-Mart Stores, Inc. (NYSE/WMT) are benefiting from the thrift spending. We are seeing excellent numbers from the operators of dollar stores, which are expanding during the recession. Top companies in the dollar store business include Family Dollar Stores, Inc. (NYSE/FDO) and Dollar Tree, Inc. (NASDAS/DLTR).

My view is that the retail sector continues to struggle and will not improve until we see an upward trend in consumer confidence and spending. The ripple effect from declining housing values will continue to spread, unless we see some stability in the credit and housing markets. Yet, at the end of the day, there must be job creation and a decline in job losses. With the unemployment rate at 8.5% and people fearing jobs losses, it will continue to be tough going for retailers going forward.

My advice is to continue to tread carefully in retail; however, sometimes the best time to buy is when there is chaos.