FINANCE

2018 Economic Forecast: The outlook is mostly sunny, but some clouds loom

BY Phillip M. Perry

Fair weather ahead. That’s the economic forecast for 2018. Retailers should benefit from an improving employment picture, growing disposable consumer income, and an easy credit environment.

“We estimate core retail sales will increase by 4.7% in 2018,” said Scott Hoyt, senior director of consumer economics for Moody’s Analytics, a research firm based in West Chester, Pa. (economy.com). “That’s an improvement over the 3.8% increase of 2017, which was virtually flat with the previous year.” (Core retail sales exclude volatile auto and gasoline segments).

The retail outlook reflects robust growth in the overall economy. For 2018, Moody’s expects gross domestic product (GDP) to grow by 2.9%, thanks mostly to vigorous residential investment and government spending. That’s a healthy increase from the 2.19% expected to be recorded for 2017 when numbers are finally tallied, a figure up from the 1.49% of the previous year.

Brisk tail winds should keep the economy in full sail

“A revival in corporate profitability, record stock prices, and rock-bottom borrowing costs are buoying businesses,” said Sophia Koropeckyj, managing director of industry economics at Moody’s Analytics.

Even the global picture is brighter.

“All of the major economies are expanding in unison for the first time in a decade,” she said.

STRONG LABOR MARKET: Perhaps the most important factor is a strengthening labor market which should put more spendable cash in consumers’ pockets.

“We expect well over two million jobs to be created in 2017,” said Koropeckyj. “This is about the same growth experienced since the expansion

Strong job growth resulted in an unemployment rate of 4.4% by the end of 2017, and that’s expected to fall to 3.94% by the end of 2018.

As unemployment declines, employers have more difficulty finding sufficient workers. That bodes well for wage growth, and for a resultant increase in consumer income that can be spent at retailers. Moody’s expects average hourly earnings to grow by 3% in 2018, up from the 2.6% increase of 2017, which was little changed from the previous year.

LOOMING CLOUDS: While consumer and business confidence remains high, the road ahead is not entirely clear.

“Lack of retail pricing power remains a big issue, with competition from online sales a big contributor to that,” said Hoyt.

And while higher wages mean fatter shopper pocketbooks, they also have drawbacks.

“There is a challenge to finding and retaining the right workers, and working out what to pay them and still deal with downward pricing pressures,” he said.

Other potential problems include uncertainties in Washington legislation, especially for the corporate tax cuts that are built into Moody’s sunny forecast. Additionally, retailers may be harmed by protectionist measures promised during the campaign of Donald Trump, if instituted. On the positive side, there has been no recent talk about a border adjustment tax.

Finally, retailers need to keep a watchful eye on the health of the banking industry.

“I continue to worry about the strength of the financial system,” said Walter Simson, principal of Chatham, N.J., -based Ventor Consulting. “When the value of assets such as the stock market and real estate goes up so high, that usually means there is too much easy money around.”

Simson is also wary about the increase in debt for student loans, credit cards, and longer-term auto loans. Furthermore, he added, financial institutions are introducing more high-risk derivative-backed CDs, and engaging in more of the loan bundling that contributed to the Great Recession in 2008.

The end result?

“Some lenders might have too many high-risk loans on their books,” said Simson. “If they cannot collect, the whole banking system will again be at risk.”

Running Start: As retailers enter the first months of 2018, Hoyt suggests keeping a watchful eye on some key indicators for the year’s economic trajectory. The first is Washington legislation.

“Will there be a program of fiscal stimulus?” posed. Hoyt. “If so, that will bolster the economic environment.”

Hoyt also suggests staying alert to reports of wage increases which would stimulate consumer spending. Finally, he said that any increase in retail pricing power will bode well for the remainder of the year.

Philip M. Perry is a New York-based business writer.

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FINANCE

Fitch Ratings: Liquidations common in retail bankruptcy cases

BY Marianne Wilson

U.S. retail bankruptcy cases more frequently end up in liquidation than other sectors, and tend to have outstanding first-lien recoveries.

That’s according to the latest addition to Fitch Ratings’ case study series, “Retail Bankruptcy Enterprise Values and Creditor Recoveries.” Fitch examined 39 U.S. retail cases filed since 2005, including nine new cases resolved since its September 2016 retail sector bankruptcy study. The new cases were Gymboree, Payless, rue21, True Religion Apparel, Aeropostale, BCBG Max Azria Global Holdings, Golfsmith International, Hancock Fabrics, and Pacific Sunwear.

“Bankrupt retailers often find themselves without a reason to exist from a consumers’ standpoint or a financial lifeline to help them rebuild, making liquidation a relatively common solution,” said Sharon Bonelli, senior director, leveraged finance. “Sometimes the operating challenges that cause a retailer to spiral into distress in the first place follow them into the bankruptcy process, creating obstacles to turning around a fallen brand.”

More than half of the 33 general retail cases studied since 2005 ended in liquidation. A number of recent retailer bankruptcies were resolved as going-concerns, albeit often with a smaller store footprint. Recent examples include Aeropostale, Gymboree, Pacific Sun, Payless, rue21, and True Religion.

Fitch believes the retail sector will remain under pressure over the next year.

“We have 17 retailers on our Primary Bonds and Loans of Concern lists, which indicate a material likelihood of default,” the company stated. “At end-November 2017, the U.S. retail term loan default rate stood at 8% — much higher than the 0.4% recorded at end-2016.”

Fitch forecasts the retail sector default rates could rise to 7% for bonds and 10% for institutional term loans by end-2018.

The full report, “Retail Bankruptcy Enterprise Values and Creditor Recoveries: Fitch Case Studies — 18th edition,” is available at Fitchratings.com.

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Five Below crushes earnings; shows strong momentum heading into holiday

BY Marianne Wilson

Teen and tween fave Five Below blew past Street estimates in its third quarter, delivering better-than-expected top and bottom line for the fifth straight quarter and opening a record number of stores.

Net income increased 81.4% to $9.9 million, or $0.18 per share, in the quarter ended Oct. 28, compared to $5.4 million in the year-ago period. Analysts had estimated $0.13 per share.

Five Below’s net sales increased 28.9% to $257.2, from $199.5 million last year. Analysts had expected $244.93 million. Same-store sales rose 8.5%, also more than expected. Traffic rose 8.5%.

“We are extremely pleased with our third quarter results that exceeded the high end of our sales, comp and earnings outlook,” said Joel Anderson, CEO, Five Below. “This quarterly performance reflects a strong customer response to our WOW product, incredible price points, differentiated in-store experience and increasingly targeted marketing efforts. With the strength of our year-to-date performance, as well as our quarter-to-date momentum, we are raising our guidance for the year.”

Five Below opened 41 new stores in the third quarter, a record for the-fast-growing chain, giving it a total of 625 locations in 32 states. On the company’s quarterly call, Anderson said Five Below remains confident in its “2,000-plus store potential” and ability to achieve 20% top-line growth with 20% plus bottom-line growth through 2020.

Anderson also praised the chain’s real estate and construction teams, which he called “best-in-class.” He said opening 41 stores in one quarter was a “great test,” and that it did not produce any stress on the company.

Five Below raised its guidance for the fourth quarter and full year. For the full year, net sales are expected to be in the range of $1.264 billion to $1.276 billion, compared with earlier guided range of $1.236 to $1.248 billion. Same-store sales are projected to rise 5.7% to 6.5%, compared with earlier guidance of 3.5% to 4.5%.

Net income is expected to be in the range of $95.9 million to $99.7 million, with a diluted income per common share of $1.72 to $1.79, compared with the previous range of $1.62 to $1.66.

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