Fitch Ratings: Retail earnings strong in Q1 but expect moderation

After a strong first quarter for many U.S. retailers, things are likely to moderate going forward.

That’s according to Fitch Ratings, which said that first-quarter earnings for U.S. retailers are proving to be a “perfect storm of strength,” as ongoing tailwinds from government stimulus and discretionary budget savings from reduced services spend mixed with budding enthusiasm over vaccines, re-openings and some return to normalcy.

Here is Fitch’s update on retail earnings for the rest of the year. 

Industry behemoths such as Walmart, Target, and Home Depot reported first-quarter revenue of up 15% to 40% above first quarter 2019 levels. Many categories are maintaining the strong trajectories experienced in 2020, with weaker segments such as department stores and apparel stores 'joining the party' due to easing comparisons and a budding desire to refresh wardrobes in anticipation of more time spent outside the home.

Department stores and apparel retailers should see continued growth through 2021, although Fitch expects overall sales to remain below 2019 levels. Margins in 2021 should benefit from tighter inventory purchases, which will limit unplanned promotional activity, while SG&A expenses remain somewhat of a wild card, as companies adjust spending levels after pulling back significantly in 2020. 

In addition, sales recovery could also be constrained by potential supply shortages. Stronger survivors in the category should also benefit in the medium term from accelerated competitive retrenchment and limited new store openings.

Beyond the apparel/department store sector rebound, Fitch continues to believe the majority of retailers, which saw good topline growth through 2020, will experience moderating trends in 2021, with some potential for revenue declines, against strong numbers and as budgets are crowded out by accelerating spend on travel, entertainment, and other services.

Fitch expects some leading retailers like Walmart and Target to sustain some level of recent market share gains given strong omnichannel models. These retailers could see revenue grow at a 3%-4% CAGR from 2019 levels through 2022, modestly higher than Fitch's expectations pre-pandemic. Target could see a sustainable lift in some discretionary categories like apparel and home, where consumers trialed Target's private brand assortment in 2020 as a means of trip-consolidation.

On the beleaguered department store front, Fitch expects the multi-year investments by Kohl's, Nordstrom and Macy's could result in market share stabilization or acceleration. Areas of focus include omnichannel capabilities (with digital penetration expected to be in the mid 30% range going forward), store remodels, and investments in various channels (like off-price for Nordstrom and Macy's) and categories like increased activewear and beauty. These retailers should benefit from store closing and restructuring activity from cash-constrained specialty apparel players and department stores, which accelerated in 2020. 

The positives are tempered by increased execution risk related to pivoting business models, as evidenced by flat to modest revenue growth for a number of years pre-pandemic and significant EBITDA margin compression in 2019. The ability to return to 2019 revenue and EBITDA levels will depend on recovery from the pandemic and execution of strategic priorities.