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Reading, Writing -- and Retailing

By Marie Driscoll, CFA Overall, retailers shouldn't expect a gold rush as America's students -- and their parents -- start preparing for a new school year. Standard & Poor's is neutral on the outlook for back-to-school (and college) retail sales for 2005 and looks for a 1% decline in year-over-year comparisons for total spending of about $40 billion.

We do see some positive factors for the coming season: High levels of consumer confidence; low levels of inflation, despite 10 interest rate hikes over the past 15 months and oil priced at more than $60 per barrel; strong employment trends; robust denim sales, especially for luxury brands; a heightened interest in fashion by both sexes; and pricing power for footwear retailers.

WANING WEALTH. We also note continued momentum in hot consumer-electronics products such as digital phones, cameras, and MP3 players; smart merchandising by discounters, where 77% of all back-to-school shoppers intend to shop, according to a survey by BIGresearch, which tracks consumer spending trends; increased advertising budgets, which should excite even the more reticent student shoppers; and projected increases in primary and secondary school and college enrollment.

But a number of negatives should be considered as well. Retailers have to contend with deflationary pricing, particularly in the consumer-electronics category for commodity-type laptops and printers, and the potential of a disappearing "wealth effect," which could take place with any blip in the economy and spark a retrenchment in consumer spending. We estimate that the number of new college freshmen and juniors will be modestly down this year, therefore any spending gains will come from firm pricing for goods or increased usage of services like cell phones or music downloads.

Other factors that could inhibit spending include the relatively high penetration of computer/laptop and cell-phone usage, which leads S&P to assume modest gains in these categories; and oil prices topping $60 per barrel, likely squeezing some consumers at the pump, leaving less discretionary income available for back-to-school/back-to-college shopping.

GIZMO-LADEN. Despite S&P's neutral stance, our equity analysts still see some winners and losers as retailers kick off fall 2005. Of S&P's $40 billion back-to-school spending estimate, electronics is likely to garner the largest share at 26%, or $10.3 billion, though this represents a decline of 3% since last year. In addition to positive demographic trends, demand for laptops, phones, and MP3 players will drive growth, in S&P's view. More than half of college freshman recently surveyed by Best Buy indicated that they plan to bring at least eight pieces of technology to school with them -- from MP3 players to computers to TVs.

It's important to note that services are becoming an increasingly important part of consumer-electronics retailers businesses, as most retailers offer add-ons such as spyware and firewall protection, home or dorm installation, and wireless products. These accessories and bundled services could mitigate S&P's projections of a 3% decline in consumer-electronics sales. With higher margins, service revenue on back-to-college spending could be a boon to consumer electronics retailers such as Best Buy (BBY

(recent price, $49; S&P investment rank 3 STARS, hold) and Circuit City (CC

$18; 3 STARS), in S&P's view.

S&P anticipates apparel sales to be a close second to consumer electronics at 24%, or $9.6 billion, though down 4% since last year. With apparel and shoes combined expected to account for an estimated 35% of the seasonal spending total, S&P sees selected teen apparel retailers, along with sporting goods merchants, performing well during the 2005 back-to-school season.

DOMINANT JEANS. With backpacks, sneakers, jeans, and Henley-style T-shirts de rigueur for new and returning students, S&P sees Nike (NKE

$83; 4 STARS, buy) and the three A's of teen apparel retailing -- Abercrombie & Fitch (ANF

$65; 4 STARS), American Eagle Outfitters (AEOS

$31; 4 STARS), and Aeropostale (ARO

$27; 4 STARS) -- all well positioned this fall. Shoppers of all ages have been asking for denim, denim, and more denim, and S&P thinks the A's have age-appropriate jean selections that provide a path to higher average unit retail and gross margin dollars.

S&P also looks for department stores J.C. Penney (JCP

$52; 4 STARS) and Kohl's (KSS

$55; 4 STARS) to appeal to back-to-school shoppers seeking moderately priced fashion apparel, denim, and shoes.

We expect trends in footwear this fall to include new twists on the well-established trend of athletic shoes crossing over for general wear. This should be reflected in styles such as track flats and sports-inspired boots. Footwear fashions will likely include "old school" looks updated with 21st century materials and embellishments. S&P expects sporting goods retailers like Finish Line (FINL

$17; 5 STARS, strong buy), which have become increasingly adept at fashioning merchandising strategies to appeal to young shoppers since the urban street look exploded on the scene, to successfully capture a greater share of kids' back-to-school dollars.

ONE-STOPS SHOPS. S&P analyzed what consumers plan to buy and where they intend to make their purchases. Intent-to-purchase trends improved year-over-year at discount stores, specialty stores, and catalog merchants, with decreased intent for the remaining channels (department stores, online, office supply, and drug stores). S&P sees Target (TGT

$56; 3 STARS) and Wal-Mart (WMT

$49; 5 STARS) as the one-stop shopping destinations of the masses, since they offer the opportunity to purchase sheets and plasma TVs at the same time as denim and sneakers.

Backpacks are integral to the school season, and S&P notes its projected 8% increase in school-supply sales, which S&P maintains is related to higher-priced branded backpacks, such as the North Face brand from VF Corp. (VFC

$59; 3 STARS).

With regard to Wal-Mart, we expect the Bentonville (Ark.)-based giant to spend much more aggressively on advertising this year. With its back-to-school ad campaign well under way, the company's back-to-college campaign is expected to begin in late August, focusing on furniture and electronics categories, which S&P thinks will capture the lion's share of prospective students' dollars.

After soft results in the second half last year, after the retailer implemented a more "balanced" ad spending strategy, S&P thinks Wal-Mart has learned its lesson. And that just goes to show that even one of the world's largest companies can learn a thing or two as another school year comes into view. Analyst Driscoll follows shares of apparel retailers for Standard & Poor's Equity Research Services

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