As retailers release earnings from 4Q18, I am keeping an eye on what companies say about the promotional environment they faced this holiday season, and looking at the effect it had on their gross margins (gross profit/revenue).
Social media platforms have enabled the emergence of agile private-label retailers that target consumers online with personalized offerings, without the burden of the fixed operating costs of a physical storefront. At the same time, the conversation surrounding the obsolescence of brick-and-mortar retail in the digital age has pushed a number of seasoned companies to make key investments in technology and logistics, expanding their omnichannel capabilities. These businesses now offer services such as buy online, pick up in store as well as in-store inventory identification and next-day shipping. Across the retail landscape, competition has grown and the bar for future competitors has been set higher.
Q4 is typically the busiest shopping season; therefore, retailers maintain their highest inventory levels of the year in response to increased consumer traffic during the holidays. Retailers that miscalculate product mix, however, are forced to offer deep discounts to clear their stores and warehouses of the excess holiday inventory. From a reporting standpoint, most retailers net discounts against their cost of goods sold (COGS); therefore, promotional pressures can be seen most clearly on the gross profit margin line (revenue-COGS/revenue).
As demonstrated in the chart above, retailers offered more holiday promotions during the 2018 holiday season than in 2017, with Black Friday discounts increasing on a year-over-year (YoY) basis. Each retailer differs in its evolution toward an omnichannel offering, and looks to match its in-store/online product mix and volume to meet customer needs. Where these companies currently stand in this transformation will guide how their margins fared in a promotional 4Q18.
Key Takeaway
As retailers report their Q4 earnings, I will be following how companies handled the YoY increase in promotions, and how this, combined with price-inventory mix, weighed in on margins. I remain broadly cautious on retail margins and think there is further room for downward revisions in consensus estimates. I currently see pockets of opportunity in credits that are approaching key turning points in their operational transformation.
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