“The Pendulum Swung Too Far” – Wall Street Slashes Retailers’ Profit Forecasts Despite Blockbuster Quarter

Somewhere out there, a cadre of dedicated contrarians convinced they'd found the next great distressed play were thrilled when brick-and-mortar retailers from JC Penney to Macy's to the Home Depot posted Q2 earnings that soundly beat expectations, largely thanks to resurgent consumer spending, most of it with the help of a trusty credit card...

...which helped sooth anxieties tied to President Trump's embrace of protectionism.

The pervasive optimism this inspired lifted the entire sector, cementing consumer discretionary as the second-best performer for the month of August (behind tech, of course). But unfortunately for traders hoping for some short-term gains, this bout of enthusiasm is already proving short-lived. Retailers have given back some of those gains already this month as the myriad long- and short-term risks facing the sector drifted back into view.

And apparently, analysts at the big Wall Street banks foresee more pain in the immediate future. To wit, the Financial Times reports that Wall Street has slashed its profit forecasts for Q3 for 52 of the 89 US retailers in S&P's retail index.

Wall Street has taken an axe to forecasts for dozens of US retailers, renewing questions about their profitability even as consumer spending buoys sales.

Projected profits for the current quarter have been reduced for 52 — almost three-fifths — of the 89 companies in S&P’s retail index over the past three months, according to a Financial Times analysis of figures collated by Bloomberg.

The downward revisions come even though a humming economy has encouraged Americans to splash out on products from skirts to games consoles.

As one analyst explained, after years of store closures, staff cuts and bankruptcy filings, the outlook for American retailers had become so bleak that investors were discounting the fact that some retailers will inevitably adapt and survive the e-commerce onslaught. In other words, "the pendulum had swung too far."

"The pendulum swung too far: retail never died, but it’s likely not as healthy as people think, either," said Simeon Siegel, analyst at Instinet. "After a very strong first half, it would seem management teams feel the need to reset the bar, to bring hype back to reality."

Meanwhile, as analysts slashed expectations for retailers...

...They hiked expectations for the nemesis of everything "brick and mortar": Amazon.

Analysts even slashed profit expectations for companies like Tiffany's amid concerns that a growing number of retailers might reinvest their profits in capital expenditures (instead of returning it to shareholders in the form of buybacks).

Jay Sole, analyst at UBS, said investments by the companies partly explained the lowered third-quarter forecasts across the sector.

"There’s been a lot of cutbacks in retail over the past 10 years," he said. "This year, profits have been bigger than expected, with the consumer shopping more. Companies are taking the opportunity to reinvest these extra profits into their businesses."

Mr Sole also highlighted cost pressures. "Despite the consumer being healthy, companies are not seeing a ton of relief from cost inflation. In particular, the costs of online operations continue to rise."

And apparently the first stirrings of sustained consumer-price inflation weren't enough to satisfy analysts' concerns.

Drew Wilson, portfolio manager at Fenimore, said: "The fact is that even though Amazon is not going to kill every retailer, online is going to take some capacity away. It’s still going to be a painful transition away from brick and mortar."

"It’s a stock story, not a sector story. There’s been a lot more optimism about the sector, which for a value investor means there’s a lot less opportunity than there was."

Of course, these concerns are nothing new. American retailers have struggled for years as e-commerce behemoths like Amazon have gobbled up market share, leaving the landscape of American cities and towns dotted with the hollowed-out husks of bankrupt big-box chains.

At any rate, the culling of the retail heard, which we have dubbed the 'retail apocalypse', is expected to continue. As we pointed out a few months back, more than 12,000 stores are expected to close this year, compared with last year’s 9,000. If these projections prove correct, 2018 will beat out 2017 for the highest number of store closures in a single year.

The bottom line: Some chains will inevitably endure - but retail will continue to be a sector where only the strong survive.