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Retailers' Summer Prices Are Insane


Deep discounts could significantly hurt margins, earnings.


Many retailers -- from American Eagle (AEO) to Nordstrom (JWN) to Zales (ZLC) -- are offering up some great bargains these days, in an effort to draw strapped consumers into their stores.

Come earnings time, however, the firms may end up paying for it - literally. Discounts that drive foot traffic could have a dramatically negative impact on margins.

''Even though retailers are entering the season conservatively, they still have been too optimistic about the consumer,'' said Dan Hess, CEO and founder of Merchant Forecast. At mall-based stores -- despite inventories that have declined as much as 15% -- discounts are 10% deeper than they were a year ago.

One should be wary of raw sales data and its meaning, and probably be careful when dropping by the local mall: Seeing a flurry of activity at a particular store does not mean earnings are about to skyrocket. Hefty discounts may also, in some cases, have an adverse impact on brand image - and gross margin trends are going to be essential.

Also important to keep in mind is the fact that holiday season is just around the corner: Some retailers are going to be heavily under the gun to make room for that
cute little dancing Santa Claus and/or the ol' Red Ryder BB Gun. This, in turn, could exacerbate markdowns, pinch margins and possibly lead to some rough results.

Keeping a close eye on bellwether types like Wal-Mart (WMT), in the discount arena, and Macy's (M), among the department stores, is also a good idea. Their margins may provide some insight into what others will experience. If they were to report weak top line sales numbers, I'd be concerned that further discounting could follow, since low prices bring more folks in the doors.

But I'm a big believer in retail over the long haul. We are still a nation of consumers, after all. At the same time, however, I think there's an awful lot of risk here, and it shouldn't be overlooked.

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No positions in stocks mentioned.

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