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A Less-Jolly Holiday for Retailers?

Holiday retail sales growth should decelerate this year as consumers' pent-up demand is tempered by uncertainty over the markets and stagnant wage growth, says Morningstar's R.J. Hottovy.

Jason Stipp: I'm Jason Stipp for Morningstar. It's Black Friday, and if you're watching this, you are not out shopping. But just how important is your business to retailers this year? Here to offer some insights is director of consumer equity research R.J. Hottovy to tell us a little bit about how important the holiday shopping season is to retailers.

Thanks for joining me, R.J.

R.J. Hottovy: Thank you.

Stipp: So, first question for you: We know that the holiday season is critical for all retailers, but looking at how retailers have done during this year, how important is this particular holiday shopping season? How critical is it?

Hottovy: As you mentioned, the holiday season, by that we define November and December, is critical for retailers. It usually accounts for about 30% to 40% of the annual sales, so you can make or break a year on your holiday sale plans.

This year, it's an important year, but I mean it's not a make or break situation for a lot of companies. I think really what we are looking for at Morningstar is a deceleration from last year. Last year was a pretty big year. The November and December timeframe yielded about a 5% increase in retail sales across the board--some more, some less--but that was the average.

This year we are looking for about a 3% gain in retail sales, and really I think what we're seeing is there's a lot of pent-up demand, but consumers are also balancing a number of macroeconomic pressures, stagnant wage growth, volatile asset markets, and generally just uncertainty with where things go in the economy from here.

Stipp: So consumers certainly are under a lot of pressure. We know one of the things they are very sensitive to are price changes. So we had some high-profile stories with Netflix having some trouble with some increases in their prices; Bank of America added fees and they had to take those away recently.

So just how much is that sensitivity, the consumer sensitivity, to price increases, going to play into pricing for retailers in the season?

Hottovy: I think retailers have been smart about not raising prices too quickly, but at the same time they are balancing a number of inflationary headwinds. For example, cotton is up on a multi-year high, down from its highs earlier in the year, but still at elevated levels. A number of the food companies, too. These are all inflationary headwinds that have to be passed on.

But at the same time I think retailers are smart and know that traffic has to be the first priority this holiday season, and so they're not going to raise prices too much, and I think they probably learned some lessons from a couple of these high media profile situations, and I don't think they're going to see too much of a price increase.

Really what we are thinking is that 3% is going to be driven a lot by traffic. We think that price increases that are already in the mix will be there, but largely negated by promotional offers that are out there or less units per transaction. So really that 3% is going to be driven a lot by growth, and I think retailers have done a smart job in not raising prices too quickly.

Stipp: What does the discounting environment looked like? It seems like earlier and earlier, we get the pre-Black Friday sales. Have you seen a lot of discounting so far just to get some of those initial shoppers in the door?


Hottovy: Black Friday pretty much starts in October this time a year nowadays, and really what we're seeing is that as more and more mass merchants and online players like Amazon have gotten into the game more competitively, it really translates into an everyday low pricing situation across the board. Certainly you have some door busters early on, on Black Friday, to drive traffic in that particular day, but what we expect over the next couple of years is that they become less and less meaningful for retailers.

Essentially with the online becoming a bigger part of a lot of these companies' businesses, they have the ability to change prices on the fly, and that's going to make it a lot less important to draw people in that one time. And so I think the e-commerce development that we've seen over the last couple of years--and we will continue to develop--is really changing the playing field in terms of Black Friday promotions and how retailers go about holidays, in general.

Stipp: Another piece of the puzzle here is the inventory levels. So, how are retailers managing their inventory levels? Do you think that we're going to see tight inventories, so shoppers need to get out there early to get what they want? Or are inventories looking pretty healthy and we might see some discounting perhaps at the end to get rid of all the extra merchandise?

Hottovy: Lean inventories are certainly one of the big stories we are following this year. It's very clean inventory environment, so I don't expect to see a lot of markdown risk, and as a result, we could actually see earnings outperform for the fourth quarter. Essentially for consumers out there, that means get to the stores earlier or shop online early. It could also result in a situation where we do see increased gift card sales this year, too. If a shopper gets there late and doesn’t see the product they want to get, a gift card might be a nice alternative for that.

Stipp: You may have to settle for that as a last resort.

Hottovy: Exactly. It may work for them.

Stipp: So what about some other trends? I know one of them we’ve been watching is the dichotomy between the high-end retailers--the Saks and the Tiffanys--and the lower end. What trends do you expect to see, and do you expect to see some continuation of trends that you’ve seen through the holiday season?

Hottovy: Generally speaking, we do expect a continuation, although there have been some recent things that may change it a little bit.

On the high end, we are generally expecting luxury sales to do quite well again this year. We are seeing double-digit gains in comparables store sales across most of our luxury names--the Tiffanys, the Coaches, and some of the more European centric names as well. But typically that consumer takes their cues from the asset markets, and with the volatility we’ve seen, even this past week, that may change the playing field. It may give that consumer a second thought about that big ticket item purchase. But generally speaking, I think we are still probably in a pretty safe situation for luxury holiday sales.

With regard to the low-income consumer, generally we are looking at more holiday purchases that can be used all year around, so kind of has an everyday feel to it. So, we do expect dollar stores to do very well this holiday season. I think Amazon, again keeping in this theme of people shopping more online, I think will do very well. We’ve seen Walmart introduce layaway programs and number of its peers like Sears do that as well. Really that’s catering to a value-focused consumer, but anybody that offers value and convenience, I think, is well positioned to capture that low-end consumer this year.

Stipp: What about on the merchandise side? Are you seeing any trends between, for example, electronics and apparel. You mentioned cotton prices being something that was a sticking point for apparel shoppers before. Do you expect to see any kind of dichotomy between some of the groups within retail?

Hottovy: What we’re expecting is really no change from the past seasons: Portable consumer electronics is going to be the hot item this year. Tablet computers, probably, are going to be the number-one seller this year. Between the iPad and the introduction of the Kindle Fire by Amazon, I think those are clearly going to be the hot items that people are getting out there for. eReaders are certainly going to be another hot topic, anything Apple-related pretty much will do very well.

In terms of apparel and other situations, I think apparel is a product that a lot of times people are out there are seeing during the holiday season, but it’s not necessarily a gift item. They’re usually buying for themselves. So, I think apparel will also do very well. That’s a situation that really depends on the merchants themselves putting out the high-quality stuff that people are demanding.

Stipp: So, lastly, R.J., you mentioned some of the hallmarks of success in the holiday season--good inventory management, smart pricing strategies. When you are looking out at some of the retailers that are doing this exceptionally well, are you also seeing that there are some good values in the stock market? So, some of your favorite retailers, are they on sale right now during this holiday shopping season?

Hottovy: In this current environment, a lot of the successful retailers and e-commerce players, the ones that have been doing very well, unfortunately have also been rewarded by either in-line valuations or even healthy premiums to what we think the intrinsic value of the stock is worth.

We do like a company like Amazon. We think the company has great long-term potential, and it’s only trading at a moderate discount or fair value estimate. But there are a few names that we think do stand out in terms of a valuation perspective--the first being American Eagle, ticker AEO, our fair value is $20 per share, and we don't think the teen apparel space is dead. We think this company does a great job managing its inventories, doesn’t ... take a lot of fashion risk, and at the same time, it’s more of a cyclical situation than it is structural situation, and the company pays a healthy dividend at the same time. So there is a lot to like in that stock.

A company like Collective Brands, the ticker is PSS, it’s a company that caters more to the low-income and on the footwear side, but I think they have a compelling brand of wholesale brands like Saucony and Sperry Top-Sider. I think that’s also a compelling name that investors should keep on their radar screen.

Stipp: All right. R.J., well some great insights on the consumer and the investor in the holiday retail shopping season. Thanks so much for joining me.

Hottovy: Thank you.

Stipp: For Morningstar, I’m Jason Stipp. Thanks for watching.

Jason Stipp does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.