Traders work on the floor of the New York Stock Exchange (NYSE) on October 25, 2021 in New York City.
Spencer Platt | Getty Images
Retailers are reporting this week.
Here’s the good news: the consumer is strong, and retail budgets have improved dramatically.
“I’ve been an optimist for over a year,” David Berman, portfolio manager at Durban Capital, told me. “There is more money to the consumer, jobs are plentiful, and demand is strong. Retailers are healthier because the number of stores is decreasing, so there is a more rational environment.”
And what about supply chain issues? “Retailers have pricing power and can pass on higher labor and raw material costs, so gross margins need to remain strong, which is exactly what happened with Home Depot,” Berman said.
Here’s the bad news: For some retailers, a lot of earnings “growth” has happened in the past decade because they have turned into “repurchase monsters” who have been aggressively buying stocks.
Retailers: Buyback monsters?
(reduced number of shares, since 2011)
- Dillard 64%
- Kohl 51%
- 38% gap
- Target 31%
- TJX 24%
- Walmart 22%
The result: Over the years, the number of shares reduced has made retail earnings appear stronger because there are fewer shares outstanding. In many cases, revenue growth was modest or non-existent.
For example, Kohl’s will have the same sales it had in 2016, but the profits are much stronger. Dillard will have the same level of sales this year as 2018, but profits are also much higher.
How does that happen? Partly by operating more efficiently, so more profit flows into the bottom line, but also partly through ongoing buybacks.
Joe Feldman, senior managing director at Telsey Group, notes that retailers give shareholders what they want.
“The investment community loves to see buybacks because it makes their stocks more valuable,” Lee told me. “It makes trends better than they would otherwise be.”
Covid has halted buybacks, but has since resumed
Several retailers, including Target, Kohl’s and TJX, suspended buybacks during the pandemic, but have since gone back to buying stock. TJX, for example, repurchased $300 million of stock in the second quarter, which was its first buyback since the first quarter of 2021.
Kohl’s repurchased the stock every quarter from the first quarter of 2010 through the first quarter of 2020, then held the buybacks for the remainder of 2020 and resumed in the first quarter of 2021, according to Ben Silverman, director of research at InsiderScore.
With increased cash flow, should companies return to buying stock?
“I’m not a big fan of stock buybacks,” Durban’s Berman told me. “I prefer that they increase their profits.”
Feldman is pushing Telsey’s retreat to the idea that retailers are ignoring investment in their business in favor of buybacks.
“The better quality companies are investing more heavily in digital infrastructure and in the supply chain,” he said. “Walmart is spending $13 billion on capital expenditures this year. But you can only do so much. These companies generate so much cash, that buybacks are a way to return something to shareholders.”
Black Friday discounts?
One thing is for sure: With the consumer flush with cash and inventory tight, don’t look for “half” sales on Black Friday.
“There may be some modest sales, but you’re not going to see huge promotions like we saw a few years ago,” Feldman said.
It’s good news for retailers, but consumers may have to get used to the sticker shock.
“There’s a lot of full-price selling that’s offsetting the higher costs,” Feldman said. “You’d still like to have some incentive to get people into the stores, but the price is mostly full price at the moment.”
What to worry about?
Not all glass is half full.
Investors will listen carefully for an update on stocks. Nobody wants to get caught up in high demand and no supply during the holidays.
There is also concern about waning stimulus for consumers, which could have a large role in spending in the first quarter.
But the big issue is the steadily increasing prices, which are a threat to profit margins.
“At some point, you can only pay as much in terms of higher prices before the consumer backs down,” Feldman said.
“That hasn’t happened yet, but it will happen if prices continue to rise.”