9/2/2010
By Brian Sozzi, Research Analyst

More Articles by Brian Sozzi

Thus far, investors have awakened to a handful of uncharacteristically robust monthly same-store sales results for early back to school.  What gives?  By most accounts, sales for back to school commenced on a sour note in August, with very modest acceleration into the latter stages of the month.  This was a notion supported by commentary by retail management teams on their 2Q10 earnings calls, as well as within initial 3Q10 guidance ranges.  In our view, the kick in of sales tax free holidays, the amplified level of discounting on early fall merchandise, and warm weather that led many back to the stores to purchase seasonal wares (retailers doing much better job of localizing inventory) aided in the partial reconciliation of the industry's pre-holiday inventory conundrum.  The dip in the savings rate to under 6% in August suggested that consumers spent somewhere, and that somewhere appears to have been the malls and discount chains once household bills were satisfied.

Let's not get ahead of ourselves, however.  Yes, while it's a positive that comp beats evidenced this morning imply that excess inventory is being whittled down, therefore alleviating one pre-holiday concern, and that there haven't been any 3Q10 earnings warnings, there are important takeaways that investors need to acknowledge.  They include:

1. Average transaction value is still in the doldrums, in many cases sharply lower.  No discounts, the consumer is willing to sit the dance out.  Depressed average transaction value exaggerates the negative margin impact from higher supply chain costs.  On the surface, very minimal pricing power in the retail sector.
2. Storm activity could negatively impact September sales.
3. We are still cycling easy year ago sales comparisons (think mid-single digit percentage negative), so how good are the demand trends across the country.  The trust test of the retail recovery will come in 2H10.

A Deeper Dive...

Of the 22 companies that we track for monthly sales, 14 of them surprised to the upside with their August comps.  It could have been worse, much worse in fact, as the consumer continues to weigh the near-term satisfaction of a purchase at retail with the uneasiness after that dollar is spent.  Such uneasiness is derived from angst on the employment front, where those that have jobs suffer through tepid wage growth and those that are jobless contend with job titles that no longer exist or have been shipped overseas.  So many variables in the economy currently, which explains the monthly volatility of the chain-store sales data.

The above point brings me to the following line of thinking.  The August sales were, for all intents and purposes, clustered in weeks two and three of the month, periods when sales tax free holidays began and discounts on fall product were ratcheted up.  For many retailers, sales moderated in week four of August, and with the lack of upward 3Q10 guidance revisions on today's reports given the comp upside, it hints that retailers are simply not seeing consistency in their numbers in non-peak shopping periods.  Now that peak back to school shopping has come and gone, has the consumer used up the gunpowder they had in their chambers?  Meaning, did consumers save up from April to July (the notorious "pause" we have heard about regarding spending) to spend on back to school and are now prepared to close up shop until the holidays?  If that's the deal, then September and October comps may be very volatile, and will expose the declines being realized in average unit retail prices.  Customer traffic has been the predominant reason that comps at retailers have not gone completely south in 2010.

In the meantime, I would expect a continued downward bias in retail shares overall as the market tries to decipher how holidays will emerge/conclude.  At the moment, all indications are that holiday 2010 will be quite promotional, which will be married to tougher year over year sales and gross margin comparisons.  From an investment standpoint, this is not an ideal scenario; one wants easing financial comparisons and negative sentiment to become incrementally more constructive.

Brian Sozzi
Wall Street Strategies