'Back To School' Winners and Losers: A Look Ahead
Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
With back-to-school spending expected to reach $53.5 billion this year, there is a significant payoff to investigating which companies are likely to benefit and which are likely to falter. Amongst some of the biggest competitors for these coveted consumer dollars are Target (NYSE: TGT), Wal-Mart (NYSE: WMT), Kohl’s (NYSE: KSS), J.C. Penney (NYSE: JCP) and Macy’s (NYSE: M). There is a clear divide between apparel and school supplies, giving discounters Target and Wal-Mart an immediate advantage given the ability of each to meet the full needs of consumers. The battle between these two behemoths is where the real action is, but taking a look at the apparel market will help place this discussion into the proper context.
The Apparel Companies
Profits and revenues have each been under pressure in this sector as seen by recent earnings releases. Kohl’s announced a decline in net income of 19.7%, from $299 million a year ago to $240 million for the most recent quarter. This decline still allowed the company to beat earnings expectations, underlining the weak expectations analysts have for the sector.
Similarly, J.C. Penney reported a decline in revenues of 22.6% to $3.02 billion. The company swung to a significant second quarter loss and effectively abandoned its price outlook for the remainder of the year. Despite this level of negative news, the company experienced a significant jump in the price of its shares when Chief Executive Officer, Ron Johnson confirmed that the company’s restructuring was on track: “We have now completed the first six months of our transformation and while business continues to be softer than anticipated, we are confident the transformation of J.C. Penney is on track. The transition from a highly promotional business model to one based on everyday value will take time and we will stay the course.” These remarks led to the 5% jump in share prices at the end of the week.
Finally, given the continued negative perception of the economy, Macy’s may have a difficult time attracting back-to-school shoppers. Many consumers have made it clear that they have no intention of buying anything that is not necessary. With apparel available at the discounters for more aggressive pricing, the department store will either see lower sales or be forced to try to compete on price, thus slashing profit margins.
The Projections and the Discounters
While the National Retail Federation is expecting the average American family to spend approximately $668 this year for back-to-school needs, some analysts believe this projection is extremely aggressive. The figure represents an increase of over 11% from the amount spent in 2011, but there are several other factors to consider. For example, the director of consumer research for Thompson Reuters points out that teen employment is at its lowest level since 1964. This means that those teens without jobs will be solely at the mercy of their parents when budgets are set. Despite the fact that the recession is officially over, economic concerns continue to weigh heavily on the minds of many consumers. With the continued pressure of employment, many Americans are concerned about the security of their income. While this new sense of responsibility and discretion is absolutely a long-term positive for the economy, in this context it will likely place added pressure on the retail sector.
Considering the choice between Target and Wal-Mart, Target looks more attractive based on various metrics as well as the direction that its corporate strategy is taking the company. Firstly, with dividend yields of 2.3% and 2.1% respectively, the slight edge goes to Target. When the dividend histories of the two companies are compared, the steady growth rate for Target is more appealing. Additionally, the expected earnings growth for Target is more appealing than the same statistic for Wal-Mart. Target is expected to experience annual earnings per share (EPS) growth of nearly 12% for the next five years; over the same period, Wal-Mart is expected to have annual EPS growth of 8.6%. Finally, where Target has an operating margin of 7.5%, Wal-Mart is only operating at a margin of 5.9%.
Corporate Strategy
The idea of moving smaller stores into more populous urban areas is not a new one; Wal-Mart unsuccessfully attempted this strategy several years ago. There are several factors, however, that may allow Target to be successful where Wal-Mart was not. Firstly, the timing of the move is more favorable for Target. Over the last several years there has been a population shift back to urban areas, meaning that more consumers are now concentrated in these areas. Furthermore, many of these individuals that are returning to the cities are accustomed to having a local Target or Wal-Mart to shop at for many of their needs; there are predisposed to shopping at the discounters. If Target becomes an option, the likelihood is that these consumers will continue to seek them out when they are available.
The other factor tilting in Target’s favor is the “cheap-chic” image the company has made for itself. This may appeal more heavily to urban populations that are likely to purchase more high-margin items than is the norm of the “big box” suburban locations. This strategy should combine with the factors discussed above to make Target the biggest winner this back-to-school season and into the future. At current levels, Target looks attractive as an addition to one’s core portfolio.
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