Its all about the Margins!
The market is making runs up to resistance points and just coming off. It seems like in the morning we attempt to make a run that will break-through, but by the late session the buyers start to fade off. Perhaps this is a lull heading into the anticipation of Black Friday sales. Speaking of holiday sales, there is a concern about margins going forward. As they say in business, it’s all about the margins!
All about the Margins!
The Secret Formula
It is important to understand the single most important formula for business, or for any household or government for that matter, is the formula that determines your Profit and Loss. This single formula determines your financial outcome, ignore it and you are doomed to failure.
Revenue – Cost = Profit or Loss
The difference between Revenue and the Cost is referred to as the “Margin”. If it costs you X and you sell for Y, the difference, which determines you profit or lose, is also the margins by which you operate. It can be determined on percentage basis, a dollar per unit basis, or any basis that reflects that difference.
Companies, households, and even governments have the most control over the “cost” portion of the formula. We all determine how much to spend on items and, of course, there are necessities, but even at the necessity level we can do some comparative shopping and further shave off some costs. If we can lower costs, we can boost margins, and therefore profit; or for households and government, save.
We have less control over the other factor of the equation, “Revenue”. For businesses, this portion is really based on ASSUMPTIONS – we know what they say about assumptions. Of course, they can do some more marketing, create sales or special offers, and a variety of other things to entice sales; however, at the end of the day, the actual decision that drives the sale is truly out of their hands and is in the hands of the buyer. The buyer must pull the trigger and the revenue must be collected before it is counted.
When measured on an annual cost basis, Black Friday marks the day when retailers actually begin to profit. Simply meaning, 100% of all revenue generated by retailers up until Black Friday is used to cover costs (employees, rent, taxes, insurance, etc.) for the entire year. Any revenue after Black Friday is profit. However, Black Friday has not only come to represent the biggest shopping day in the United States, but also acts as the official kick-off date to the holiday sales season.
Each year companies compete and try to open a little earlier. It is a silly and ridiculous game in which companies are actually opening in the early evening on Thanksgiving this year just to catch that early RUSH of customers who are eager to buy what they could have already purchased the day before. Personally, I find the ritual as absurd as it is silly and what is sad is that statistics from last year show it is driven mostly by the lower-middle income crowd. Many of them which are struggling with access to credit, jobs, and debt.
This year there is an additional problem with the holiday shopping season being one of the shortest on record (time between Black Friday and Christmas), as Thanksgiving falls on the 28th (the latest date it can be). This has shortened the holiday sales season by 6 days and some reports show the loss of those 6 days will cost retailers North of $1.5 billion.
Per-Holiday Sales (Cutting the Margins)
News reports already show that not only is there a race to open early, but pre-holiday sales have seen huge price reductions, which significantly impact margins. A report yesterday has an already struggling J.C. Penny offering steep discounts (below cost) to move existing inventory. It is literally so cheap it is almost FREE – like jeans for a $1.50. Other stores are following suit, with Walmart and Target both offering steep pre-holiday sales. Walmart has announced that starting one week before Black Friday it will meet or beat any competitors advertised Black Friday prices. Gap sent out a 50% off coupon for store-brand card holders, stating “shop our Black Friday event one week early”. Best Buy is creating “door buster” deals that will be as good as or better than Black Friday sales. Sears announced, “get Black Friday prices on 1,000 items one week early”. The list goes on and on, but the concerns are starting to rise for investors on 4th quarter earnings. One retail analyst pointed out that we are seeing price cuts as steep as one would see in the post-Christmas sales. Cutting margins this steeply early or selling items below cost just to move inventory might boost top line sales, but it will certainly impact the bottom-line. While the concerns listed from analysts differ in their explanations, the common theme is THIN MARGINS.
Earnings and Warnings
Courtesy of wikipedia
Target’s (TGT) third quarter revenue rose by 4% to $17.26 billion and sales were up 0.9%, both below analyst expectations. The problem is clearly margins, if you look at the difference between top-line revenue and sales vs. the cost. Earnings fell to $341 million from $637 million, or 54 cents a share vs. 96 cents a share a year earlier. That’s a whopping 46% CRUSH and a massive squeeze in the margins. The company blamed the “constrained” U.S. consumer and said that it must continue to offer discounts and promotions to win over consumers, which means cutting the margins. The company lowered its full-year profit forecast and the stock is down over 3% in pre-market trading.
Target isn’t alone; a host of companies that compete in the middle to lower income bracket have stated similar concerns. Last week Walmart (WMT) reported a small decline in comparable sales for the third quarter. Sears (SHLD) reported U.S. comparable fell 4%, Dollar Tree (DLTR) said their sales rose far less than expected. Abercrombie & Fitch (ANF) is forecasting double-digit percentage declines in comparable sales.
Attracting consumers = cutting margins
As we are seeing, these stores NEED to move inventory and get revenue in the door, even if it means selling at or below cost. They are ramping up promotions and offering steep discounts in pre-holiday sales. While I suspect we could see a net record in sales and even top-line revenue, which could boost initial market optimism during the holiday sales, we could be setting up for some disappointing earnings at the end of the 4th quarter, which reflects that the margins were squeezed and these companies made far less profit.
However, I don’t think this will impact all stories. Luxury brands will most likely see continued strong profits and there is still solid consumer growth in the emerging markets. What it does reflect is that those big retailers are heavily dependent on the middle-lower income households who continue to struggle with credit, debt, jobs, and income. They will have a difficult year when we measure it on the margins.
Support & Resistance
Do we make another attempt higher? It seems like we will, judging by the pre-market futures. Or, will we just sell off by the late afternoon trading session? There is not really much news out there to drive this either way at this point.
The NDX has seen some big intra-day volatility over the last couple of weeks, moving well over 100 points. However, it has remained very close to that 3400 level since mid-October. Holiday sales from some of the big tech items and new products could drive some optimism in the 4th quarter.
This has been trying to get up to and through that 1800 level for five days; we may just try again today; however, the longer we wait with no real optimistic news the higher the probability that the buyers will eventually fade. The VIX is still holding in the 12 range, popping above 13 every now and then, so no real warning signs yet.
Is 1100 the new support area? It could be, but I would still be watching the 1080 level in case we slip. Continue to keep your eye on the RUT to measure general order flow.
We continue to see a separation of two economies. The luxury brands and emerging markets continue to prosper, while the Western middle class and lower income continue to struggle with a mountain a debt, limited access to credit, low wages, and a weak job market. That story is also playing out in the retail sector and I suspect we will see a dichotomy in the holiday sales between the luxury brands and technology vs. domestic retailers that cater to the middle and lower income class.
The margin story is certainly not good and while we might get an initial bump in optimistic expectations as the first wave of sales and top line revenue reports come in, it will not be until the 4th quarter earnings are revealed that we see that this was really a quarter of weaker margins.