Tuesday, March 27, 2007

Consumer Slow Down?

Consumers Clench Their Wallets
Worries over mortgages and higher gas prices are starting to show up in their spending. And from Tiffany's to Wal-Mart, retailers are feeling the pinch
by Pallavi Gogoi
BW Exclusives
At first blush, it's easy to overlook the lackluster results posted by luxury jeweler Tiffany & Co. (TIF)—flat income and 15% sales growth, the stuff of a tepid quarter at a retailer known for its affluent and loyal clientele. Yet a closer examination of Tiffany's performance offers an interesting peek into how the folks who shop there—a broader demographic than many people realize—are starting to behave amid new economic uncertainties.
In fact, recent earnings and sales numbers released by Tiffany and other stores, such as J.C. Penney (JCP) and Macy's parent Federated Department Stores (FD), offer signs that the middle class is starting to show spending restraint. Climbing gasoline prices are already hurting lower-income consumers, who have responded by curtailing their shopping at retailers like Wal-Mart Stores (WMT). Even such inexpensive stores as Dollar General (DG) are feeling the pinch.
But the current slump in the housing market seems to be sapping some wind from the credit-card sails of middle-income shoppers. "People are worried about housing and the mortgage situation," says David Wyss, chief economist of Standard & Poor's, which, like BusinessWeek, is a unit of the McGraw-Hill Cos. (MHP). "And home mortgages are more of a middle-class issue—the rich usually don't have mortgages, and the poor rent."
No Slowdown for the Rich
And if the middle class is looking for some comfort, it hasn't come yet. The U.S. Commerce Dept. reported on Mar. 26 that sales of new single-family homes fell by 3.9% in February, to a seasonally adjusted annual rate of 848,000, the slowest sales pace in nearly seven years (see BusinessWeek.com, 3/26/07, "A Nasty Surprise on New Home Sales").
All regions of the country except the West experienced weakness last month. The February decline followed an even larger 15.8% sales drop the previous month. "When people have jumbo mortgage loans to pay off and also higher costs of health care, child care, and other services, you just can't afford any overheads," says Richard Hastings, vice-president and senior retail analyst at Bernard Sands. "I call it the trickle-up effect."
At Tiffany, the super-rich continued to spend at a prodigious pace—the average price per item sold in the U.S. rose to $91,000 from $81,000 in 2005, a 12% increase. However, those slightly lower on the income scale appear to be holding off on new Tiffany treats in the face of uncertainty.
General Restraint
It showed in the sales data: At the lower end, the average price per unit sold of Tiffany's silver jewelry in the U.S. rose just 2%, to $191 last year, vs. $187 in 2005. "We've noted a greater than expected shift in sales mix towards higher-end jewelry," Mike Kowalski, chairman and CEO of Tiffany, said in a Mar. 26 conference call discussing the results. The New York company's net income for its fiscal fourth quarter ended Jan. 31 barely budged, to $140.5 million, from $140.3 million last year on sales of $986.4 million, a 15% increase over last year's $858.4 million in the same period. Tiffany executives say higher cost of precious metals and diamonds ate into margins in the quarter.
Besides Tiffany, sales at other stores also seem to point to emerging signs of consumer restraint. J.C. Penney, the Plano (Tex.) department store chain favored by middle-income shoppers, reported a 0.2% decline in February sales at stores open at least one year, a key retail metric known as same-store sales. And Macy's parent Federated's sales rose a mere 1.2% in the same month, below the company's own guidance for a same-store sales increase of 2% to 3%.
Overall, shoppers generally shied from spending. The Commerce Dept. reported that in February, sales fell 0.3% at electronic stores, 1.2% at restaurants, 1.8% at clothing stores, and 1.7% at furniture retailers (see BusinessWeek.com, 3/15/07, "Consumers Feel a Chill").
Crunched Credit Scores
Analyst Michelle Tan of UBS (UBS) Investment Research believed that the mess in subprime loans would have a negative effect on housing-related retailers and reiterated her "reduce" ratings on home-improvement stores Home Depot (HD) and Lowe's (LOW). "We expect broader implications of the subprime fallout to remain limited to housing-related categories," Tan wrote in a Mar. 26 report.
On the lower end, the pressure is already showing. Wal-Mart, the world's biggest retailer, saw same-store sales rise an anemic 0.9%, missing its prediction for a 1% to 2% increase in February. And on Mar. 26, discount retailer Dollar General said its fourth-quarter profit fell 66%, to $50 million, on the costs of store closings and reduced prices.
Dollar General earlier this month agreed to be purchased by private equity firm Kohlberg Kravis Roberts. Clearly, people are hunting for deals at the lower end too. And even though short-term interest rates are falling, low-income consumers may not be benefiting. "Even if stores give 0% financing, many lower-income folks might not have credit scores that are good enough for them," says Hastings. "People are stretched."
Gogoi is a contributing writer for BusinessWeek.com.

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