Retail: The Cart Is Half Full

-- Retail sales will steam ahead, despite a slowdown in some big-ticket purchases. But merchants will have little room to cut costs

-- Low prices and innovative offerings will make registers ring at Wal-Mart, Kohl's, and Target

After a decade-long spending spree, Americans are finally stuffing their credit cards back in their wallets. That could slow consumer sales growth to a 12-year low of 2% in 2003. So that means the year will be a bust for retailers, right? Wrong. Although Americans are expected to buy fewer big-ticket items such as cars--those no-interest financing deals are drying up--they'll likely keep the registers ringing at the mall. Retail spending will rise 5.8%, to $1 trillion, compared with a 5.5% increase in 2002, estimates Mike Niemira, senior economist at the Bank of Tokyo-Mitsubishi in New York. "It's almost a rebalancing of consumer priorities," Niemira says. "Consumers will be spending less overall, but more on retail."

Merchants shouldn't put on their party hats quite yet, though. While many retailers managed to boost profits last year by beating down supplier pricing, cutting staff, and slashing inventory, their sales growth came largely through heavy discounts and promotions. Now, with ongoing pricing pressure from global competition and a glut of retail space, merchants don't have much room left to increase earnings by cutting costs, says Carl Steidtmann, chief economist at Deloitte Research. "Businesses will have to focus on productivity, technology, and consolidation," says Steidtmann.

Shoppers will be pickier, too. More consumers, trained to wait for deals during the past few years, will shun department stores and flock to discounters. And discounters will keep barreling deeper into goods such as groceries, upscale apparel, and higher-priced consumer electronics. That will increase pressure on the likes of Circuit City (CC ), grocer Albertsons (ABS ), and Federated Department Stores (FD ). Still, innovative retailers and department stores such as Pacific Sunwear (PSUN ), Neiman Marcus (NMG ), and Nordstrom (JWN ) are expected to prosper. Why? They offer unique product lines and aren't overbuilt.

Coming off a strong holiday season, online commerce should maintain its white-hot streak, rising 35%, to $70 billion. The number of households with high-speed Internet service is expected to jump 37%, to 29 million, by the end of next year, according to Forrester Research Inc. That will help e-tailers, since consumers with broadband access spend 22% more than those with dial-up connections, Forrester says.

Amazon.com Inc. (AMZN ) remains the bellwether for online retail and is expected to post a $22.6 million net profit in 2003. But Amazon will have to decide whether it can continue to offer free shipping on orders over $25. If Chief Executive Jeffrey Bezos bumps that back up to the previous level of $49, sales growth could slow. Meantime, competition is heating up as savvier traditional retailers such as Best Buy Co. (BBY ) and Sears, Roebuck & Co. (S ) move into Amazon's territory. There, they will also confront a hardy group of remaining dot-coms, including eBay Inc. (EBAY ) and Overstock.com. (OSTK )

The bloodiest battles will take place in suburban shopping strips. Wal-Mart Stores Inc. (WMT ), the nation's biggest retailer, plans to open nearly 500 new locations in the U.S. and abroad this year. And after rolling out higher-end apparel for women last year, it plans to add Levi's blue jeans and pricier men's clothing and accessories in 2003. That should help the company boost earnings 16%, to $9.2 billion, says Lehman Brothers Inc.

Wal-Mart continues to force others to craft creative strategies for living in its shadow. Kohl's (KSS ) and Target Corp. (TGT ) both have carved out profitable turf by offering consumers broad selections of brand-name products at low prices. Kohl's will continue its march into new markets, adding 80 stores in the Southwest and increasing its sales and earnings 22%. While Target has struggled with a foray into groceries and faces problems in its credit business, the company should continue to pick up shoppers who abandon its bankrupt competitor, Kmart Corp. (KM )

Among specialty retailers, Gap Inc. (GPS ) will move back into the lead after a couple of tough years. Even as rivals such as Abercrombie & Fitch Co. (AWF ) and Bath & Body Works suffer from overexposure and a dearth of must-have styles, Gap's earnings are expected to jump 53% in 2003, to $564 million, according to brokerage Sanford C. Bernstein & Co. Gap kick-started a turnaround late last year by dumping its black-and-white theme and ushering in brightly hued clothes and striped hats and scarves. "They basically have gotten back to their knitting and into color," says Bernstein analyst Emme Kozloff. Gap's experience could be a primer for retailers this year: Shoppers will keep shelling out, but only to those who deliver real value.

By Heather Green in New York

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