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Retailers face headwinds this holiday season

With investors and consumers getting more nervous about the rise in oil prices and meltdown in the mortgage markets, the outlook for the holiday shopping season is turning cautious.
Image: Christmas decorations at Macy's in Philadelphia
A Christmas light show is tested at Macy's in Philadelphia. Retailers typically make 40 percent of their annual profits in the final six weeks of the year.Matt Rourke / AP

With investors and consumers getting more nervous about the rise in oil prices and the meltdown in the mortgage market and the housing market, the outlook for the holiday shopping season is turning cautious.

Retailers face strong headwinds going into their most important season — when the industry looks to book roughly 40 percent of its annual profits in the last six weeks of the year. Though the economy continued to post a solid performance in the third quarter, consumers are beginning to feel stretched — just as the retail industry tries to get them in a spending mood.

“We expect (retailers') operating performance to soften over the next few months as the prolonged downturn in the housing market, a cooler labor market, high gas prices and tighter consumer credit result in a slowdown in consumer spending,” said Richard Baldwin, an analyst at Moody’s Investor Services, a credit rating agency.

Retail trade groups are sticking with forecasts of modest gains, but the final results won’t be known until early in 2008, when stores have fully discounted leftover inventories and most of an estimated $80 billion in gift cards have been redeemed.

Heading into the final weeks of the year, the National Retail Federation is sticking with its forecast of 4 percent sales growth over last year, which would amount to $475 billion for the last two months of the year. As of Monday three-quarters of those surveyed said they had completed less than 10 percent of their holiday shopping completed, the NRF said.

"Good news lies ahead for many retailers whose shoppers have yet to put a dent in their shopping lists," the group's president and chief executive Tracy Mullin said in a statement.

The NRF has a mixed tracked record on forecasting holiday spending, according to numbers compiled by Frank Acito, a professor of marketing at the Kelley School of Business at Indiana University. Based on Census data tallied after the shopping season was over, Acito found that NRF tended to overestimate sales when the economy was weak and pulling out of a recession earlier in the decade. But it underestimated retail sales growth when the economy was strong in 2005 and 2006.

Though industry giant Wal-Mart posted strong profits in the third quarter, the company is forecasting only modest sales gains for the rest of the year — compared to last year’s ho-hum holiday results. Wal-Mart said this week its third-quarter profits were up 8 percent from a year ago on sales gains of just 1.5 percent, not counting fuel sales. (Rising fuel prices helped boost overall revenues 9 percent higher than a year ago.) The company said it doesn’t expect sales of store merchandise to rise more than 2 percent in the final quarter compared with a year ago.

There are some signs that a slowdown in consumer spending may already have begun. Chain-store sales rose just  1.6 percent, the weakest October gain since 1995, the International Council of Shopping Centers reported. And consumer sentiment dropped in early November to its lowest level since the aftermath of Hurricane Katrina, according to the University of Michigan.

With pump prices rising and home prices falling, consumers have been finding credit harder to come by. Tighter credit is also becoming a problem for retailers. After this summer’s credit scare brought big losses to holders of bonds backed by risky mortgages, investors have gotten skittish about all credit risk. That’s especially true for retailers who are carrying higher levels of their own corporate debt. Moody’s has negative ratings on Macy’s, TJX Cos., Eddie Bauer and Blockbuster, all of which are carrying debt at more than three times their cash flow.

“Years of private-equity buyouts have left many speculative grade retailers with large amounts of debt and relatively limited free cash flow,” Baldwin wrote in a recent Moody’s report. “In many instances, capacity to absorb less-than-planned operating results is modest.”

The outlook for retailers is not universally bleak; a lot depends on what they’re selling, say analysts. Toy stores will likely feel some of the fallout from a wave of product safety recalls. But demand remains strong for the latest generation of big-screen TVs, personal computers and video games, which should help big electronics retailers like Best Buy, according to Mitch Kaiser, a retail industry analyst at Piper Jaffray.

“What we've found in the past, historically, is that product cycles have trumped economic cycles,” he said. “And we would we expect Best Buy to be one of the few retailers to have a pretty good holiday season.”

In years past, retailers have responded to sluggish sales by slashing prices and pushing discounts sooner than usual. That means consumers who do open their wallets can expect to find bargains this year. Some of those discounts have already started.

Wal-Mart has begun advertising discounts on some items to get holiday shoppers started earlier than usual, telling customers they don’t need to wait for the traditional race to the shelves when the doors open on the morning after Thanksgiving. Those discounts may help boost foot traffic, but they won’t help boost the bottom line. And while they may shift sales earlier in the season, starting promotions before Thanksgiving may simply undercut sales closer to year-end.

With more shoppers going online or opting for gift cards, retailers may have a tougher time gauging how far — and how fast — to cut prices. In the past, many had used Black Friday — the traditional shopping kickoff on the day after Thanksgiving — to gauge demand for the rest of the year. As more sales have shifted to the Internet, those transactions have become an important barometer for the overall shopping mood. Despite the weak store traffic in October, online retail business for the month was up 19 percent from a year ago to nearly $10 billion, according to comScore, which tracks Web traffic.

As gift card sales have increases, the season has spread well into January; retailers typically book sales when gift cards are redeemed, not when they’re sold. Consumers who hold onto cards may wind up missing promotional sales and discounts — making their purchases more profitable when they eventually get around to redeeming their cards.

Most retail stocks have taking a pounding this year, though they perked up a bit on news that Wal-mart had a better-than-expected third quarter. Still, the industry faces the prospect of weaker spending through the remainder of the year, which has some investors looking for other places to put their money.

"We don't like any of retailers and for a straightforward reason," said Barry Ritholz, a money manager who writes a blog on the stock market. "It was a weak back-to-school season; we had a poor September and October. I don't think retailers are desperate, but they're definitely nervous."