Retail recovery rated unlikely in '02

Don Hogsett, September 9, 2002

New York — In one more unnerving sign that there's still more pain to go around as antsy consumers hold on tight to their dollars, Fitch Ratings, one of the Big Three corporate credit agencies, said the recent slide in consumer confidence, and renewed fears about the job market, make a retail recovery unlikely until some time next year.

Fitch had earlier forecast a retail comeback some time during the second half of this year, especially given the easier comparisons that retailers face with a fourth quarter that was blighted last year after terrorist attacks in New York and Washington.

But now, said Fitch's retail analysts, "there are signs that consumers are becoming more cautious," with confidence levels skidding down in July and August. "Moreover, retail sales trends weakened in July and August, injecting additional uncertainty into the 2002 holiday selling season." Given the clouded outlook, Fitch said it "now believes that a meaningful recovery will not take place until some time in 2003."

"Retailers continue to struggle to restore top-line momentum, with comp-store sales growth tracking at a low single-digit pace in the first half of 2002," said Fitch retail analysts. "Many factors have contributed to the weak environment, including anemic economic growth, weakened consumer confidence and growing levels of consumer debt."

Moreover, said Fitch, "Recent corporate scandals and accounting irregularities have added to capital market volatility, leading to more questions about the direction of the economy. The bankruptcy filing by Kmart Corp. in January, along with the pending liquidation of Ames Department Stores, underscores the stress that the difficult environment has placed on the industry's weaker players."

Given an unsettled economic environment, and fears that consumers are pulling in their horns, Fitch said retail sales and profits may be harder to come by, and "there have been more downgrades year-to-date among the retailers than had been anticipated. And Fitch has put out downgrades on Kmart, Saks, The Gap, Toys "R" Us, McDonald's and JCPenney. And where it hasn't actually slammed a retailer with a downgrade, it has revised its outlook lower, as with Federated Department Stores where the outlook has shifted from "stable" to "negative."

There's lots of blame and pain to go around as the retail malaise backs up on suppliers, and Fitch has tagged the outlook "negative" on such major vendors as WestPoint Stevens, Levi Strauss and Hasbro.

Throughout this year, said Fitch, the outlook for the retail industry continues to skew negative. And its analysts scope out the business by channel of distribution.

DISCOUNTERS Fitch said it has "stable" outlooks on Wal-Mart, Target and Costco, "as they have continued to successfully expand and gain market share at a time when their competitors are retrenching. ShopKo, on the other hand, has a "negative" ratings outlook due to operating difficulties and significant competitive pressure from Wal-Mart and Target. Kmart has continued to post weak results in bankruptcy, raising questions about its ability to emerge from Chapter 11. Fitch believes Kmart will be challenged to carve out a defensible position longer term vs. Wal-Mart and Target.

The outlook here is also mixed, said Fitch. "The recent revision of JCPenney's outlook to "stable" from "negative" reflects progress the company has made in turning around its department store and drugstore operations." On the other hand, the outlook for Federated and Saks has slid to "negative," reflecting "the difficulties facing the department stores as they strive to generate growth in the face of increasing competition from the discounters and specialty apparel retailers."

Among the big boxes, Fitch has "stable" outlooks on the two home improvement operators, Home Depot and Lowe's, "reflecting the strength of the sector as consumers have shifted their purchasing from apparel to home-related goods." But the outlook for some others is "negative," including Radio Shack, "in response to its unanticipated weakness in sales." The negative outlook for Toys "R" Us, said Fitch, "reflects the challenges it faces as it attempts to stem the erosion of its market share vs. the discounters. Gap's negative outlook will stay in place until it demonstrates its ability to successfully merchandise its concepts and turn around its sales trends." With so many retailers stung by a sales decline that began more than a year ago, Fitch said that during the first half all of its rating changes among retailers "have all been to the negative side; and the pace of activity has accelerated from 2001 levels," with 10 downgrades so far this year, compared with seven for all of 2001.

Despite the sluggish environment, said Fitch, "many retailers have been able to generate improved margins this year as they have managed their businesses conservatively, keeping a tight rein on inventories and expenses and preserving liquidity. With a lack of profitable growth opportunities, many retailers have also greatly scaled back their capital spending, instead using cash flow to repurchase their debt and equity on the open market."

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