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Too Many Retailers, Not Enough Shoppers

The bad news didn't stop with Christmas for retailers. After most chains posted lower-than-expected holiday sales and warned that fourth-quarter earnings would fall short, now they have to grapple with a slowing economy. What happens next may not be pretty. A steeper-than-expected decline in consumer spending has already resulted in lowered 2001 earnings forecasts for nearly every retailer. That will put the brakes on the long surge in retail-space expansion. But now the sector looks to be badly overbuilt.

Growth in new retail square footage accelerated to an annual rate of 5.3% in the second half of the 1990s, up from 4.7% during the first. The nation now has 5.6 billion square feet of retail space -- a sizable 20 square feet per person. With big retailers' financial returns being squeezed, a much-needed shakeout seems inevitable. "The good news is [the current retailing environment] is forcing companies to behave more rationally and marginal companies to be forced out of business," says Richard L. Church, an analyst with Salomon Smith Barney.

There's blood in the water. Troubled Montgomery Ward and Bradlees finally pulled the plug recently and will shutter hundreds of stores. Sears (S) has disclosed it will close 83 of its specialty tire and hardware stores and four of its mainline department stores. Office Depot (ODP) said it would close 70 stores and cut back on expansion. On Feb. 9, the New Jersey-based housewares retailer Lechters (LECH) announced that it will close 166 stores and take a $44 million charge against earnings. Circuit City (CC), Nordstrom (JWN), and Gap (GPS) have all slowed planned expansions.

ON TARGET. Never mind that, say strong retailers, including Wal-Mart (WMT), Target (TGT), Costco (COST), Kohl's (KSS), and Family Dollar Stores (FDO). They're all continuing to add new stores at a breakneck pace. "You have to have a clear strategy and stick to it in good times and bad," says Gerald L. Storch, president of new business at Target. "We can have twice as many stores in the U.S. as we now have."

Wall Street is still betting big on the entire retailing sector. Buoyed by the Federal Reserve's recent rate cuts, retailing stocks tracked by Bloomberg have surged 20% since Oct. 12 -- the group's recent low -- even as stocks generally have trended downward. But some analysts expect investors to become more selective if earnings shortfalls continue. "It appears the fundamentals are not supporting the valuations [of] these stocks," says Credit Suisse First Boston analyst Michael Exstein.

The biggest winners as the economy slows are likely to be bargain-oriented outfits such as Costco, Wal-Mart, and Family Dollar, which appeal to shoppers on tight budgets. "Off-price retailing is in as good a position as one could get if the economy gets a little weaker," argues Sherry Lang, a vice-president at tjx Cos.(TJX), operator of the t.j. maxx stores. The company's shares have nearly doubled, to about $30, since late last summer. But such aggressiveness, combined with the slowing economy, "is a double whammy" on also-ran chains, says Joel Benoliel, Costco's senior vice-president for real estate.

THE NEXT CHAPTER? Ames Department Stores (AMES), a Northeast regional discounter, is already suffering from the encroachment of a more efficient Target and Wal-Mart, which helped put Bradlees to an end. Ames announced 32 closings late last year, and analysts predict more. With the stock tanking, analysts are wondering if Chapter 11 bankruptcy protection could be next. The company stresses that it isn't considering such a move. It reduced new-store openings from 26 to 5 and is moving ahead with those because they're already under way.

Dillard's (DDS), a regional department store chain that's struggling with declining earnings, could close or sell as many as 12 of the troubled Mercantile stores it acquired in 1998, Church predicts. He also speculates that Saks (SKS) could close some of its poorly performing traditional department stores, which were merged into the upscale retailer when Proffitt acquired the company in 1998. Saks also announced it's backing out of its plans for an initial public offering for the high-end Saks Fifth Avenue stores.

Analysts think other department store chains, such as Federated Department Stores (FD) and May Department Stores (MAY) also may come under pressure. Federated announced it's shuttering all 24 stores in its Stern's chain, most of which will be converted into Macy's or Bloomingdale's. Brian James, a retail analyst at Loomis, Sayles & Co., a Boston investment firm, expects that Home Depot (HD) and rival Lowes (LOW) could be forced to cut growth plans as sensitive housing economy weakens.

LIMIT-ING LOSSES? In the overcrowded specialty-apparel sector, analysts predict there will also be consolidations, growth cutbacks, and possible store closings. On Jan. 3, for instance, teen retailer Wet Seal Inc. (WTSLA) acquired the 19-store Zutopia division from Gymboree Corp.(GYMB). Lazard Freres analyst Todd Slater predicts that Limited Inc. (LTD) could shed some of its Structure and Limited stores, two of the company's divisions that aren't profitable. Limited didn't return calls.

The problems in retailing could reverberate for some time to come. That's because store openings are planned -- and committed to -- as much as a year in advance, so there's usually a lag before cutbacks occur. The upshot? An appropriate sign for many retailers to hang on their front doors this year might read, "Please, Shop 'til you drop -- or we drop." By Robert Berner in Chicago

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