What Macy's & Dollar General earnings are telling us about the consumer

High inflation and economic uncertainty has led consumers to pull back on their spending. Forrester Research Retail Analyst Sucharita Kodali explains what the impact will be on retail stocks.

Video transcript

- All right. Well, let's check in on these retail names here. We have Macy's reporting earnings today, sharing a similar warning to what we just heard about Dollar General. The consumer is slowing down amid high inflation. Shares of Macy's, though, trading to the upside today, up just about 1.7%. We want to bring in a Sucharita Kodali, Forrester Research retail analyst. Sucharita, it's great to see you here.

So first, I guess, two different retailers, one more of a department store, one more of a, obviously, dollar store here, Dollar General, both reporting that the consumers are pulling back on their spending. What does this tell you just about the state of retail right now and the position that so many of these names are in heading into the second half of the year?

SUCHARITA KODALI: Yeah. So retail following the pandemic has had some of its best years ever. 2022 was a record high. And we saw that even in spite of inflation. So at the same time, we know that there is pretty negative consumer confidence. And there is the constant talk of an economic downturn in spite of other positive indicators like low unemployment and high wages. So you have all of these confounding factors.

And, basically, what you're seeing in retail is just that the shopper is just catching up to some of that negative sentiment and the fact that they've already been spending at record high levels. You're finally seeing the effects of inflation, particularly in non-energy goods, kind of catching up with them. They're hesitating purchasing.

It was quite insane that we actually saw people purchasing at the level that they did in 2022. There was not nearly as much trading down or stopping purchasing that we thought there would be in light of the inflation. But we're finally seeing it now in 2023. And I think that that is what you see reflected in both the department store sector as well as the dollar sector.

- Hey, Sucharita. So with Macy's looking at their improvements there with inventory control and bringing down a lot of that sort of old stock they have, stock reversing a little bit here, but still warning there about their outlook. What's your take on that? Is it more of a substitution play, people trading down?

SUCHARITA KODALI: So I think that Macy's has a lot of things, actually, that it has invested in and these are good things. They've invested in marketplaces. They've invested in on-site advertising through retail media. They've had these new formats like outlet that you described. They've had smaller format stores. They're moving to non-shopping center locations. So all of these are good things within the Macy's strategy.

The challenge for Macy's, though, is that it is operating in a fundamentally declining sector. The department store sector has been down trending pretty much since 2000. And it was particularly adversely affected during the pandemic. And its recovery hasn't even come back to 2019 levels. There are some retail-- I mean, Macy's has actually outpaced some of the other players in the sector like, say, a JCPenney or a Kohl's.

But the truth is is that this sector is just fundamentally not growing. And it's facing a ton of competition online and offline. So it has all of that. It's running to stay in place really is what the strategy ultimately comes to.

- So Sucharita, what does that mean for markdowns here, at least in the near term? Are more promotional activity likely?

SUCHARITA KODALI: Most likely, yes. We know that any time a retailer is looking to goose up sales, promotional activity is the easiest way to deliver that tomorrow. And so you typically will see an anniversarying-- so a repetition of anything that you saw a year ago-- and then beyond that, you'll see deeper discounts on more products for longer periods of time. So for any retailer, Macy's and others, that's a pretty standard textbook strategy when the fundamental demand for your goods may not be there.

- Looking a bit kind of upscale at the luxury consumer-- in my beat, I follow automotive and mobility. And we've seen sort a very unending bid there. People are buying, buying, buying. Automakers like Bentley to Rolls-Royce, they've been jacking up pricing, and people are still buying. It doesn't seem to matter to them. Is that sort of the same trend you're seeing in the retail luxury space with LVMH, players like that?

SUCHARITA KODALI: Yeah. LVMH. Kering. They continue to do pretty well, at least for now. The Chinese consumer is spending again. The lockdowns there have been kind of-- they're pretty much back to normal there. So that consumer is going to buoy those luxury retailers, whereas 2022 was really a North American story. So luxury absolutely has been relatively resilient. And the market is rebounding too, which helps some of those really affluent consumers feel comfortable purchasing the goods that they are purchasing.

What was actually surprising was that when the market was down, the luxury consumer was still purchasing. And that that's a head scratcher. But kind of, clearly, it suggests that there was a lot of money that consumer had and was ready to burn.

- Sucharita, who is best positioned in this environment, given the fact that there are so many different scenarios going on, or trends I should say, that we're seeing from the consumer in terms of what they're spending on and how they're spending? Is it the discounters? Is it people like Target and Walmart who are best positioned? I guess, who do you like in this type of environment?

SUCHARITA KODALI: Yeah. I mean, typically in any type of uncertainty, mass merchants do really well. So yes. Walmart. Target. And normally, we would say that the dollar channel would do very well in an economic environment like this. But I think that what we're seeing is that inflation is finally catching up with that demographic in addition to the fact that, to their credit, the dollar stores don't appear to be passing on the inflation hikes from their suppliers on to the shopper.

So when you're asking who's doing, well, it's often the brands who are doing well because it sounds like a lot of them, these large consumer packaged goods companies, are profiteering. And they're the ones that are really kind of rewarding their shareholders at this time.

- Sucharita, another theme that we've heard time and time again from a number of these retailers is the shrinkage, the theft that's going on, the impact that that's having to profits. I want to play a quick sound bite from Target's earnings call, CEO Brian Cornell, what he had to say about that and then get your reaction.

BRIAN CORNELL: We continue to contend with significant headwinds caused by inventory shrink. The problem affects all of us, limiting product availability, creating a less convenient shopping experience, and putting our team and guests in harm's way.

MICHAEL FIDDELKE: We now expect that if current trends continue, shrink will reduce our full year profitability by more than $500 million compared with last year.

- So Target CEO warning the $500 million this year to shrink. That's what the company could potentially lose. How do retailers address this issue? Is there more that they can do in order to combat this massive headwind that a number of them are facing?

SUCHARITA KODALI: Well, a shrink comes in different formats. And certainly theft is one piece of it. It's also many times just poor understanding of where merchandise is and not being able to find it in the right place at the right time. Or it could be sitting in a back room somewhere. So part of the shrink solution absolutely is going to be about better security in a store and maybe better lighting in certain areas and things that are related to typical loss prevention issues.

Other times, it's going to be technology to just be able to better identify where items are in a store. And that could be solutions like RFID or other types of shelf monitoring tools so that kind of items aren't lost in a 100,000 square foot venue.

- So sticking with Target here, Target and number of retailers downgraded today by JPMorgan talking about, among other things, student loan repayments coming back. Is that a real concern, do you think, for these sorts of retailers and big box like Macy's?

SUCHARITA KODALI: So I think that the issue of debt is absolutely something that the retail industry, particularly some of the most distressed retailers, are absolutely grappling with and that that's a challenge. The truth is that-- and certainly in an economic environment like this where we know that interest rates are much higher than they were even a few years ago, that is absolutely something that is challenged.

So you have two things working against you. You have the fact that demand may be softening at a time where you also have your payments to make and it is not as easy to borrow. So absolutely. We can most likely expect to see more retail bankruptcies. I'm not going to name any specific names. But absolutely in probably the next 12 to 24 months.

- Sucharita Kodali, always great to have you. We'll have to have you back to talk a little bit more if, in fact, we do start to see many more of those bankruptcies. All right. Well, coming up, the bipartisan bill.