Dana Telsey Senior Managing Director and Head of Retail Group Bear, Stearns & Co., Inc.
March 22, 2004 Dana L. Telsey Senior Managing Director Bear, Stearns & Co. Inc. 212-272-6052, firstname.lastname@example.org Bear Stearns does and seeks to do business with companies covered in its research reports. As a result investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please read the important disclosure and certification information at the end of this report. OVERVIEW OF THE RETAIL INDUSTRY
BSC Chief Market Economist John Ryding expects GDP growth of 5.1% in 1Q04 and 4.7% in calendar 2004, fueled by both stronger business investment and less robust, but still solid consumer spending.
Consumer confidence has wavered.
After strong increases in December and January, consumer confidence has wavered in February and March.
High-end retailers showing strength, while lower-end retailers are waiting for wallets to open.
High-end retailers demonstrated notable sales gains as the economy and stock market accelerated.
The prospects for lower-end retailers are more tied to the labor market, which is recovering slower than the equity market. This suggests that discounters and mass merchants could see upside with increases in jobs data.
The labor market is firming.
The gradual improvement in the labor market is expected to accelerate in 2004. More employment translates into higher disposable income and spending.
Forward indicators of labor market activity have gained traction: the average work week has increased, average claims have trended lower, and temporary help is growing.
Our channel checks indicate that U.S. retailers are squarely focused on remaining “lean and mean,” which bodes well for margins.
Price deflation persists.
Retailers continue to face price deflation, highlighting the importance of effective inventory management.
Apparel prices have declined for four consecutive months, following increases of 0.5% and 0.2% in September and October, respectively; prices were down 1.6% over the past twelve months in February.
First-half of 2004 presents easier same-store sales comparisons.
In 1H03, retail comps averaged 2.0%. In 2H03, retail comps averaged 4.6%.
Retailers expected to announce firm 2004 financial/operating objectives upon release of 4Q03 EPS.
Budgets for remodeling of existing and opening of new stores and investments in systems are underway.
Retailers have excess cash and little debt.
Retail stocks could see gains in 1Q04, if historical trading patterns persist.
On average, the BSC Retail Composite has increased approximately 6.0% and 8.2% in 1Q and 4Q since 1990; while, the S&P 500 has only risen 1.8% and 6.8% in 1Q and 4Q, respectively. During 2Q and 3Q, the BSC Retail Composite on average has gained 2.6% and lost 3.9%, compared to the S&P 500, which has increased 3.4% and has decreased 2.4%, respectively.
Dana L. Telsey (212) 272-6052
RETAIL INDUSTRY OVERVIEW Dana L. Telsey (212) 272-6052
Same-Store Sales and the Economy Appear Poised For Improvement.
Top line trends should benefit from tax refunds in 1H04 and more full price selling given lean inventory levels.
Retailers have favorable comparisons in early 2004 that become more challenging post-Easter.
The consumer outlook is brighter given the better mood (war fears LY), improving employment backdrop, and rising stock market.
What Will Drive the Top Line in 2004? A Lucky Handful Can Count on Square Footage Growth.
In an environment where same-store sales have been inconsistent, retailers who have room for unit expansion have an edge in realizing revenue growth (but watch those sales productivity levels!).
Square footage growth or unit expansion is typically a more reliable predictor of top-line growth, as store openings are planned up to a year in advance.
Specialty Stores: We currently forecast 2004 square footage growth as follows: ANN 12%, ROST 12%, TJX 8%, TLB 7%. We anticipate essentially flat square footage comparisons at both GPS and LTD in 2004.
Department Stores/Discounters: We currently forecast 2004 square footage growth as follows: KSS 17.3%, WMT 8.4%, COST 6.0%, TGT 7.2%.
Hard Lines: We currently forecast 2004 square footage growth of 11%, 9%, and 9% at BBBY, HD, and WSM, respectively.
The Promotional Environment — What is “Full Price”?
Promotional activity has become prevalent and creative in recent years through 2003, with specialty retailers offering shallow discounts, volume pricing deals on key items, and bounce-back promotions to drive sales.
No retailer wants to lose market share or be left holding too much inventory: if it takes discounts to move the merchandise, retailers have demonstrated their willingness to go there.
However, with leaner inventory levels entering 2004, department stores and specialty retailers appear poised to soften their promotional stance, in concert with more favorable consumer demand trends.
The Competitive Environment: It’s A Jungle Out There!
Differentiation is essential.
Product newness is integral, as department stores become more competitive with new lines available.
Mall-based retailers compete with off-the-mall rivals (notably KSS, TGT, and WMT), which has led to continued promotions for specialty apparel retailers. Discounters are also testing mall-based formats.
Cash is being invested in store remodels as many specialty retailers have not updated their formats in years. Fewer new mall openings requires retailers to modernize in order to lure mall traffic into their stores.
RETAIL INDUSTRY OVERVIEW Dana L. Telsey (212) 272-6052
THE SEASONS OF RETAILING Dana L. Telsey (212) 272-6052
Gap Inc. – Three leading apparel brands in Gap, Old Navy, and Banana Republic with market power. Solid senior management team and strong functional coordination across all three brands.
Limited Brands - Dominant position in the intimate apparel market with Victoria's Secret. Turning around Bath & Body Works: a high margin business with a vast 1,600 store distribution network.
The TJX Companies, Inc. - Leading off-price apparel retailer with a large and sophisticated buying organization: competitive advantage.
Main Contender: Chico’s.
Burberry Group Plc - Growing retail presence in the key U.S. market; expansion of product assortment to include more accessories (which enhances both profitability and brand perception); reinvigoration of the men's business.
Coach, Inc. - Continued retail expansion in the U.S. and Japan.
Tiffany & Co. – The jewelry market is highly fragmented, and we believe that branded jewelers are very well positioned to take share from local, independent jewelers.
Main Contender: Compagnie Financière Richemont SA.
Costco Wholesale Corporation - Merchandise expertise and customer focus drives comps and high membership renewal rates.
Federated Department Stores, Inc. - Differentiated merchandise assortment due to successful private brand initiatives.
Wal-Mart Stores, Inc. – Wal-Mart will continue to dominate the retailing landscape through its everyday low price strategy which is supported by its world-class distribution and systems network.
Main Contender: The May Department Stores Company
Best Buy Co., Inc. - Customer centricity initiative focused on better understanding the company's best customers and meeting their total home entertainment needs.
Bed Bath & Beyond Inc. - Decentralized model allows store managers to tailor assortments to local tastes and demands, driving traffic.
Lowe's Companies, Inc. - Core competency and competitive advantage remain its ongoing departmental resets and line reviews to keep the stores looking fresh and the assortment relevant, even in segments that have exhibited strong growth, such as appliances.
PETCO Animal Supplies, Inc. – Strong customer loyalty program allows company to "know its customer"; continuous investment in store base to maintain fresh and relevant shopping experience.
Williams-Sonoma, Inc. – WSM’s key competitive advantage is the development and operation of distinguished and well-recognized, vertically integrated brands that are sold through multiple distribution channels (retail, catalog, and internet).
Specialty retailers have been upgrading the fashion and quality elements of their assortments to compete more effectively with apparel offerings from discount retailers.
Will The Gains Realized in 2003 Continue in 2004? We Think So…
Specialty apparel retailers appreciated 33% in 2003 versus the broader market gain of 26%. Strong performance may continue in 1H04, as favorable comparisons can translate into sizeable double digit earnings growth, on average.
“ 400/800 Rule”: when retailers expand beyond the superb 400 malls and 800 strip centers in the U.S., same-store sales typically decelerate.
Heavy Promotional Activity and Tight Inventory Management.
Use of aggressive markdowns to keep inventory levels clean.
“ Squeezing the Middle” with Vigilant Expense Management.
To mitigate the impact of lackluster same-store sales, companies have focused on keeping tight control over expenses. This should facilitate operating leverage should sales trends accelerate in 2004.
“ Home is Where the Heart Is.”
Since September 11th 2001, consumers have demonstrated a “cocooning” instinct.
Consumers Are Increasingly Price Sensitive.
We believe that consumers will remain highly price sensitive, favoring off-price or discount retailers. Specialty stores and department stores have been escalating the fashion and quality of their assortments to present shoppers with a more alluring value proposition.
Dana L. Telsey (212) 272-6052 RECENT TRENDS IN SPECIALTY APPAREL
Department Stores/Discounters Dana L. Telsey (212) 272-6052
Consumer demand for digital products have led to increased sales momentum.
Consumers continue to invest in their homes.
Housing market activity remains at high levels, but the pace of mortgage refinancing has slowed considerably this year.
The office superstores made a conscious decision over a year ago to focus more on the business customer, and less on the average individual consumer. Merchandise assortments have been shifted appropriately.
Pet Supply Superstores
Growing services businesses at the pet superstores retailers drive top line gains and margin enhancement. In addition, both retailers have enjoyed a beneficial gross margin impact from the ongoing product mix shift away from lower-margin food products and towards higher-margin supplies, services and accessories.
We anticipate movie rentals will be down mid-to-high single digits vs. the year-earlier period, which benefited from blockbuster titles such as Sweet Home Alabama and My Big Fat Greek Wedding .
Dana L. Telsey (212) 272-6052
Drug Stores/Grocery Stores/Bookstores Dana L. Telsey (212) 272-6052
There are more than 35,000 drug stores nationwide which are operated by traditional chain pharmacy companies, supermarkets and mass merchants. In addition, there are another nearly 20,000 independent pharmacies.
2002 sales for all traditional drug stores (chain & independents) were $153.0 billion and are estimated at $165.0 billion for 2003.
In 2003, 8.90% of all single copy magazine purchases were sold at drug stores.
According to Book Industry Trends 2003, Domestic Consumer expenditures on all books are expected to reach $43 billion by the year 2007.
Overall preliminary 2003 bookstore retail sales reached $16.2B, up 5.6% from $15.8B in ’02.
In 2003, 12.43% of all single copy magazine purchases were sold at bookstores.
Grocery stores ranked among the largest industries in 2002, providing 2.5 million wage and salary jobs. In 2002, there were about 86,000 grocery stores throughout the Nation.
2002 grocery store sales were $443.3 billion and are estimated at $456.6 billion for 2003.
In 2003, 42.75% of all single copy magazine purchases were sold at supermarkets/grocery stores followed by discount stores, bookstores and drugstores.
More than half of all supermarket magazine sales are purchased from the checkout display.
Dana L. Telsey (212) 272-6052 Source: American Booksellers Association; Bureau of the Census, Current Retail Trade Branch Book Industry Study Group, Inc. New York, NY; U.S. Department of Labor: Bureau of Labor Statistics Grocery Store Headquarters; ”Front-End Focus” study by Dechert-Hampe/Masterfoods USA National Association of Chain Drug Stores (NACDS); The NEW Single Copy, Harrington Associates, LLC, March 8, 2004 U.S. Census Bureau; Bear, Stearns & Co. Inc. Estimates; US Dept of Labor: Bureau of Labor Statistics BOOKSTORES OVERVIEW GROCERY STORES OVERVIEW
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Dana L. Telsey
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