What Do These Three Retailers Reveal About the U.S. Economy?

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Retail stocks fell last week, after weak quarterly results from Wal-Mart (NYSE: WMT), Macy’s (NYSE: M) and Nordstrom (NYSE: JWN) raised serious concerns regarding the health of the U.S. economy. Consumer sentiment across the country also fell in August from a six-year high, dropping from 85.1 last month to 80.0. Analysts on average had expected a reading of 85.5.

That big miss, backed by poor retail earnings, hinted at a major slowdown in consumer spending, which accounts for nearly two-thirds of the country’s GDP. Lingering doubts regarding Europe’s recovery and China’s ability to continue growing also dampened international prospects for retailers. Should investors get out of retail stocks for now, or buy the dip?

The widening wealth gap

Retail sector investors need to be aware of one macro factor above all else: the wealth gap. Even though employment numbers have improved over the past year, so has the cost of living and housing prices. This disparity has created a difficult environment to accumulate discretionary income -- the lifeblood of the retail sector. According to a recent Gallup poll, a family of four in the United States needs at least $60,000 annually to make ends meet -- a difficult situation considering that the median household income in the United States is currently at $50,000.

Therefore, businesses catering to the middle class consumer, such as Wal-Mart, have been hit the hardest by the widening wealth gap. Luxury brands, which cater to more affluent customers, such as Tiffany & Co. and Michael Kors, on the other hand, have been spared from the decline.

Wal-Mart is running out of things to blame

In recent quarters, Wal-Mart has blamed its lackluster top and bottom line growth on a myriad of macro factors, such as payroll tax hikes, tax refund delays, lower discretionary income, and the weather. What Wal-Mart shies away from blaming are its two real problems: e-commerce and dollar stores.

E-commerce giant Amazon has been a thorn in Wal-Mart’s side for more than a decade, and that pain has intensified after its introduction of barcode scanning apps that have turned Wal-Mart’s stores into giant showrooms. Dollar stores, such as Dollar General, Family Dollar and Dollar Tree, have positioned themselves strategically in lower income neighborhoods, in closer proximity to shoppers who are concerned about fuel costs. Dollar stores have also been upgrading their stores from thrift stores to full grocery stores in a bid to steal market share away from Wal-Mart.

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For its second quarter, Wal-Mart’s earned $1.24 per share, up from $1.18 per share in the prior year quarter, in line with analyst projections. Revenue rose 2.3% to $116.9 million, falling short of the consensus estimate of $118.09 billion. U.S. same-store sales declined 0.3%, a sharp drop from the 2.2% growth it reported a year earlier. The company also slashed its full year sales growth forecast from 5% to 6% down to 2% to 3%, blaming the usual suspects: the lingering effects of the payroll tax, higher gasoline and grocery prices, delayed tax refunds and inflation.

Although those effects caused some of Wal-Mart’s losses, I urge investors to also consider the impact of dollar stores and Wal-Mart’s lack of e-commerce revenue, which it hopes to grow to a meager 2% of total sales by the end of the year.

A tale of two department stores

Macy’s and Nordstrom, which are frequently mentioned as the more successful mall anchors in comparison to industry laggards J.C. Penney and Sears Holdings, also reported lackluster earnings.

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Macy’s, which had been long regarded as a turnaround business model for J.C. Penney to follow, earned $0.72 per share in the second quarter, up from the $0.68 per share it earned a year earlier. Analysts, however, had expected $0.78 per share. Revenue slid 0.8% to $6.07 billion, missing the consensus estimate of $6.07 billion. Same-store sales fell 0.8%. Macy’s also reduced its full-year same-store sales forecast from 3.5% to a range between 2.0% to 2.9%.

Like Wal-Mart, Macy’s CEO Karen Hoguet blamed waning discretionary income for its weak top line growth, but also added that shoppers were spending more on non-department store categories, “such as cars, housing and home improvement.” Macy’s, which operates its namesake stores and Bloomingdales, is struggling with attracting shoppers with waning discretionary income in a rocky economic recovery.

A glaring disparity

By comparison, Nordstrom fared much better than Macy’s, with earnings that rose 24% year-over-year to $0.93 per share, topping the $0.75 that analysts had expected. Revenue rose 6.3% to $3.2 billion, but still fell short of the consensus estimate of $3.3 billion. Same-store sales, however, rose 4.4%.

The disparity between Macy’s and Nordstrom is a clear indicator that the middle class, which Macy’s targets, is losing spending power while the upper class shoppers who frequent Nordstrom are still making purchases. However, Nordstrom also reduced its full-year same-store sales growth from 3.0%-5.0% down to 2.0%-3.0%, in line with reductions at Macy’s.

Macy’s and Nordstrom both share a similar approach to offering full-priced products at their namesake stores and offer cheaper, off-price products at their respective lower-end Bloomingdale outlets and Nordstrom Rack locations.

The Foolish Bottom Line

Wal-Mart, Macy’s and Nordstrom are all counting on the back-to-school season, one of the most important seasons for retailers, to boost sales through the end of the year. However, reports from teen apparel retailers such as Aeropostale are forecasting a weak back-to-school season this year as shoppers curb their discretionary purchases. Therefore, the outlook for the U.S. retail sector looks pretty bleak for the rest of the year.

I believe that this examination of Wal-Mart, Macy’s and Nordstrom, which respectively represent lower, middle and high income shoppers, paints a clear picture of where investors should be putting their money -- in higher-end retailers and luxury brands. I also believe that Macy’s lackluster earnings, in particular, hint at disastrous earnings ahead for J.C. Penney and Sears Holdings, which have fared far worse than Macy’s or Nordstrom over the past five years.

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Leo Sun has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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