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Are We Recession-Bound? Results From Wal-Mart and Low-End Retailers Suggest 'Maybe'

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What investors are seeing among off-price and discount retailers is not encouraging.

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Quarterly earnings news, especially from the lower end of the retailing segment, makes it look as though we are possibly going into a recession.

Shoppers at relatively high income levels are not feeling as much economic pressure as others, so Gap (NYSE:GPS) stores reported solid earnings, and results for Macy's (NYSE:M), while somewhat disappointing, were not really bad. The bulk of American shoppers fall into lower-earning income groups, however, and for them, these are troubled times.

In that area it is widely known that JC Penney (NYSE:JCP) and Sears/Kmart (NASDAQ:SHLD) have been giving up market share and could well be in bankruptcy within one to two years, even in the presently slow GDP growth environment. Add in a recession and the situation gets even uglier.

For me, a longtime bear on the US consumer's situation, the environment seems to be even worse than I previously thought. My jaw dropped when a brokerage firm analyst did a study in the wake of Ron Johnson's mistakes at JCP. The study showed that its lost business went heavily to Wal-Mart (NYSE:WMT) and off-pricers TJX Companies (NYSE:TJX) and Ross Stores (NASDAQ:ROST) rather than to Kohl's (NYSE:KSS) and Target (NYSE:TGT). Being sure that I am savvier on this than Bill Ackman, I have to believe I would have been right even three to five years ago, and that this phenomena is a reflection of 14% real unemployment. This quarter's results also show that Sears is in an accelerated state of decline as its flagship appliance business is in an accelerated decline; this shows in its numbers and in strong same-store sales numbers at Lowe's (NYSE:LOW) and Home Depot (NYSE:HD).

Over in the teen area, Abercrombie & Fitch Co. (NYSE:ANF) reported disappointing earnings and guidance. Reflective of the weak economic environment, relatively lower priced Hollister's same-store sales were markedly lower than flagship Abercrombie & Fitch. American Eagle (NYSE:AEO) had very poor sales and lowered guidance two weeks ago. Aeropostale (NYSE:ARO) -- whose prices are far below those of Abercrombie, Hollister, and American Eagle -- had very poor sales results as well. While most investors know that Forever 21, H&M, and other fast-fashion operators have been taking market share, especially for women, things seem to have gotten worse in the economy, or market share gains by fast-fashion operators are accelerating.

I saw one surprisingly disconcerting fact in Ross Stores' quarter: Same-store sales grew 4% while juniors was one of the two biggest areas of sales strength. Then remember that packaways (supplies of last year's seasonal merchandise packed away for sale the following year) are generally 40-45% of Ross' sales. So, some generally style-slavish teens are willing to buy heavily into last year's fashions to get lower prices than they can get at even the fast-fashion operators.

Target has been pushing consumables to get people into the stores, and in doing so has probably lost a bit of its cheap-chic image. Kohl's gains over the past four to six quarters have been coming only on low prices (which still have not helped the store gain any real share of the disaffected Penney shoppers). Kohl's store brands Candie's, Apt. 9, and others have not worked well with consumers. The stores are too cluttered, the presentations are terrible, and the color palette of the clothes is always off, looking somewhat downscale.

So, there is a lot of flux and market share to be gained by one of possibly two operators. Who is most likely to get that share?

Not Wal-Mart. As bad as things are, people do have standards. Wal-Mart might have had a small chance with the decluttered stores of a few years ago, but since it brought back power-alley and the 10% of SKUs that it cut, the ambiance is terrible for shoppers who were not loyal customers already even if Wal-Mart had some stylish clothes.

I just cannot believe that there's been a huge increase in the number of people are willing to spend lots of time on "treasure hunts," sifting through broken-sized clothing "assortments." So, off-pricers are not likely to be the big winners here. Some analysts believe that people will go to off-pricers for name brands while others in the area are mostly using store brands. I discount this. Many of the brands at these stores are almost made for the off-pricers and the whole downscale area below Macy's is too big for many branded clothing companies to not play in.

JC Penney could make it and pick up the pieces if Sears dies first, but it would be a long, hard road and it's not investable now.

Sears will die, I believe, regardless of what happens at JC Penney.

I see Target as the most likely market-share winner. It can resurrect its cheap chic with relatively little effort. It will probably have to, as consumables are not providing the sales lift it desires. Target will likely get a lift from the coming demise of Kmart.

Kohl's will need to clean up its stores a lot and secure some national brands that work. That can be done, but given the fact that JC Penney customers did not flock there, I have to wonder if the price-value relationship of its clothing was not good enough for many consumers.

Based on what I see in teenland, and knowing that we have yet to face crises about college costs and student debt, I would not be surprised if Target and Kohl's picked up a lot of market share from teen-oriented retailers based largely on price, especially if there is a recession.
Position in LOW.
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