Date: Wednesday, November 24, 2021
Source: The Wall Street Journal
The Covid-19 pandemic was supposed to deliver a knockout punch to department stores and specialty retailers. Instead, many of them are bouncing back healthier.
Profits are exceeding 2019 levels at companies ranging from Macy’s Inc. M -7.45% to Ralph Lauren Corp. RL -2.50% Dozens of chains restructured through bankruptcy or worked to shed money-losing locations and now have stronger balance sheets.
Even the supply-chain problems bedeviling companies have produced a silver lining: it has helped retailers break a cycle—at least temporarily—of overbuying and discounting that has eroded profits for decades, executives and analysts said.
“We were carrying too much inventory for years,” Macy’s Chief Executive Officer Jeff Gennette said Thursday. “Through the pandemic, our opportunity to work through our stock and get in line with demand is a benefit we’ll hold on to going forward.” He said stocking fewer goods translates into less cluttered stores, which is a better experience for customers, and results in more full-priced sales.
“It’s not pile it high and let it fly anymore,” Joanne Crevoiserat, CEO of Coach parent Tapestry Inc. said last week, referring to an industry maxim about selling large quantities of goods at low prices. Ms. Crevoiserat said Tapestry had begun reducing inventory even before the pandemic. “We’re not competing on price anymore,” she said.
Retailers have long had to walk the line between not having enough goods and missing out on sales, and having excess items that need to be marked down. In the past, they have tended to err on the side of having too much. During the pandemic, every retailer faced inventory challenges at the same time, making a reset possible.
“Retailers want to maximize sales,” said Karen Katz, the former CEO of Neiman Marcus Group. “That is the nature of the game.” She added that it is unclear whether the lure of higher margins and stock prices will be enough of an incentive to keep inventories lean going forward. “It’s a real question,” she said.
Discounts have been around since the dawn of retailing. But they started to become destructive in the 1980s, as retailers went on a huge expansion spree and opened thousands of stores. The shift to overseas manufacturing led to a surge in low-cost goods. And the rise of Walmart Inc., Target Corp. and other discount chains as well as fast fashion put added pressure on department stores and specialty retailers to compete heavily on price at the expense of their bottom line, executives said.
“We had too many stores chasing too few customers,” said Craig Johnson, the president of consulting firm Customer Growth Partners LLC. “Retailers were competing for a smaller piece of the pie.”
E-commerce worsened the problem by allowing shoppers to easily search out the best deals online.
Excessive discounting diminishes brand equity, which requires even more price cuts, the executives said. “You had customers who got hooked on the discounts,” Mr. Johnson said. “They’d only buy when things were on sale.”
J.C. Penney Co. tried to move away from discounts in 2012, but lost $4.3 billion in sales in a 12-month period. Macy’s also tried unsuccessfully to wean shoppers off discounts over the years. “Customers stopped shopping, so we knew that was a bad idea,” Terry Lundgren, who was then Macy’s CEO, told The Wall Street Journal in 2013.
More recently, Macy’s has simplified its pricing by reducing overlapping promotions. That strategy, coupled with less inventory, is boosting profits. The company said Thursday that its sales and profits for the most recent period exceeded those of the year-ago quarter and also of the same quarter in 2019.
“One of the positive effects of Covid was that we got religion around inventory,” Larry Grischow, executive vice president of supply chain and procurement for Abercrombie & Fitch Co., said last week. “We learned we could do more with less.”
The newfound pricing power is helping to offset the rising costs of labor, shipping and raw materials, the executives said.
Other factors that had weighed on the industry, such as too many stores and unhealthy companies saddled with debt, have begun to ease. Oliver Chen, senior equity research analyst at Cowen Inc., describes the months since the pandemic’s start as the “great retail reset.”
From 2017 through 2020, department stores and specialty chains closed 13,760 more stores than they opened, according to research and advisory firm IHL Group. Although they continue to close stores, the pace has slowed to roughly 469 net of openings this year.
“The problem was less an oversaturation of stores, and more an oversaturation of discounts,” said Simeon Siegel, a senior retail and e-commerce analyst at BMO Capital Markets. “Retailers over the last few decades pushed growth for growth’s sake and profitability was left at the door. The pandemic forced everyone to realize that selling more didn’t mean selling better.”
Many of the least healthy retailers filed for bankruptcy in recent years and restructured their balance sheets, including J.Crew Group Inc., J.C. Penney Co. and Neiman Marcus Group Ltd.—putting them on stronger footing. Others, such as Pier 1 Imports Inc. and Lord & Taylor, closed all their stores and re-emerged online only.
The percent of U.S. retailers that defaulted on their debts spiked to 20% last year, compared with 6% for all corporate issuers tracked by S&P Global Ratings. This year, the retail default rate has fallen to about 1.5%, more in line with the broader market.
“Retailers really took it on the chin in 2020,” said Sarah Wyeth, S&P’s sector lead for retail and restaurants. “Most of them came back with balance sheets that are more sustainable. They are benefiting now from the pent-up demand.”
Now, the question is whether companies can remain disciplined as the supply-chain backlogs ease and demand normalizes from heightened levels.
“Companies have been talking about having leaner inventory and higher margins for years,” said Jay Sole, an executive director at UBS, who covers the retail industry. “This year, it’s been done for them. But will it happen next year? It implies a level of cooperation in the industry that doesn’t exist. If someone sees an opportunity to take share by discounting, they’ll do it.”
John Idol, the CEO of Michael Kors parent Capri Holdings Ltd. , said he is already seeing some of his competitors start to discount more, but added that he has no plans to do the same.
“We’re not going to start to go down that path,” Mr. Idol told analysts earlier this month. “We know where that leads, and that leads to typically lower gross margins and trying to sell too many units and trying to chase too much business. And that usually is something that, long term, doesn’t end the way that you want it to.”