Retail Stocks: A Question of Survival

Three news items from the last 24 hours should heighten worries about any company that relies on consumer spending:

1. The consumer confidence index hit a record low of 37.7 in January, from 38.6 in December. 2. The National Retail Federation expects retail sales to decline 0.5% in 2009. But, in the first half of the year, sales are expected to plunge 2.5%. (The fourth quarter of 2009 — harder [impossible?] to forecast because it’s further away — is projected to salvage the year a bit with a 3.5% uptick in retail spending.) 3. axp, which just reported dismal earnings, says U.S. card members spent an average of $2,758 in the fourth quarter, a whopping 13% decline from a year ago.

For the economy, the question of consumer confidence is crucial. “The lack of confidence across the nation is feeding the economic and financial crisis,” says Tony Crescenzi of Miller Tabak. “A recovery in confidence is crucial to ending the crisis.”

We may see an uptick in confidence in the weeks after the inauguration of Barack Obama, Crescenzi says. He notes “confidence levels are often correlated with presidential approval ratings,” which for Obama are quite high compared to Bush’s ratings.

But a new president alone is unlikely to erase the huge problems retailers face. For investors, the consumer discretionary sector is a minefield.

Many retailers (see: Circuit City) have already gone bankrupt. And conditions are obviously getting worse.

Retail companies might seek a buyer who can save them from Circuit City-type liquidation. But investment bankers I spoke to yesterday (for a story on the M&A environment) were not optimistic. Said Mark DeGennaro, managing director at investment bank Gruppo, Levey & Co.:

“That’s a sector [i.e. retail] that is really in free fall,” says DeGennaro. “There is way too much supply for demand in the foreseeable future.”

In such an environment, the calculations of stock market participants shifts significantly. Instead of worrying about growth prospects, investors should worry about survival. Does a retailer — or another consumer discretionary firm — have too much debt to outlast the credit crunch? Or does it have enough cash and cash flow to survive a consumer strike?

“Everyone would be well-served to look at balance sheets now,” independent market strategist Doug Peta told me, referring not just to retail firms but all stocks. Forecasting earnings is very hard these days. An important alternate consideration, Peta says: When will firms have to return to credit markets to get the cash they need to operate?

At least some retailers look well-prepared: In November, the Gap (GPS), for example, had $1.5 billion in cash on its balance sheet and no debt. But, for the Gap and other retailers, we’ll need to wait for until next month for earnings reports to show how much of that precious cash remains after 2008’s brutal holiday season.

These retail and consumer data points are important for the general outlook for the economy. But for stock investors holding retail stocks, the main question comes down to dollars and cents — in other words, survival.

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