Slowing Down and Trading Down
By TRG Advisors on June 2, 2022
Retailers Note a Shifting Consumer
The combined impact of inflation and re-opening has created a shift in consumer shopping behavior – opposite the shift experienced at the onset and height of the pandemic. Consumers are shifting away from stay-at-home technology and entertainment and toward travel, beauty and essentials. They’ve also shifted away from goods in favor of services, which makes up a significantly greater portion of the U.S. economy. In the second revision to the Q1 GDP print, consumer spending increased at a 3.1% annual rate, and this was driven by a 4.8% annual increase for services consumption while goods figures were flat. It’s important to note, services accounts for 70% of U.S. consumption.
Some retailers have positioned themselves better than others to capture the shifting demand. There’s become a growing focus on excess inventories because of overordering at some retailers that were late to adapt or simply bought the wrong items that consumers wanted. Target (TGT) indicated that consumers bought fewer appliances in favor of luggage and sunscreen (experiences). But overordering is a theme we’ve been monitoring across retail and other areas (e.g., semi-conductors).
According to Goldman Sachs, Personal Consumption Expenditures (PCE) in April reported the wallet share of spending on away-from-home increased slightly, while stay-at-home decreased slightly. Share of gasoline and other energy products, clothing and footwear, luggage/similar personal items and food services now track above pre-pandemic levels. The aggregate spending on away-from-home increased +21.9% y/y – now above pre-pandemic spending levels for the category. We’ve been highlighting this trend for a while, and it’s become clear that certain retailers were unable to capture this shift in Q1, while others have.
Chart 1: PCE Remains Elevated, Despite Possibility of Peak1
Is the Consumer Shifting or Slowing… and by How Much?
A combination of slowing sales and easing supply chain challenges have left some retailers with excess inventories in certain categories. As a result of overordering and excess inventories, retailers are being (or will be) forced to sell these products at discount prices. Some retailers, like Macy’s (M) have stated this explicitly, while others held back from confirming that to be the case. Discount-selling because of excess inventories has negative consequences on profit margins and revenue mix. Companies with limited excess inventories have recently outperformed those that struggled with inventory accuracy. The good news is that the heavy promotions that are now expected will help ease some inflationary pressures.
Whether you view it as a shift or a slowdown, retailers continue to cite overall consumer demand as robust. Home improvement, for example, was widely reported as slowing in Q1 but is against very difficult y/y comparisons in 2021 – remember, in Q1 2021 there was a steep acceleration from 2020 in stay-at-home, home-improvement sales because of rising home prices, work-from-home and excess cash. Retail sales across these categories were expected to decelerate amid a backdrop of rising interest rates and y/y base rates. This is one of the main reasons we look at the three-year “stack” levels of sales to smooth out results – retail sales are up 32.8% from April 2019.
Walmart (WMT) said that their inventory levels are up 33% – much higher than they’d prefer – and “the majority of that is not only inflation, but […] improvement in availability across the entire network” as available inventory became more than they expected and what they ordered wasn’t what consumers wanted. These excess inventory levels incur higher costs to store – particularly the bulky categories that include kitchen appliances, TVs and outdoor furniture. Fuel and shipping costs continue to impact company bottom-lines, but price realizations are strong – and with supply chains easing, the story has shifted to whether retailers are stocked with the right goods, rather than whether they have the goods at all.
Analyzing the Trade Down Phenomenon
Trading down tends to occur when there is a recession or high inflation. Consumers look to give up premium, higher-price options in favor of those that cost less. Trading down trends include shifting away from luxury brands, favoring discount items and emphasizing essentials. Sales for higher-priced name brands can also suffer in favor of off-brand, inexpensive alternatives. Lower-income consumers tend to be the primary group to exhibit such behaviors, as they are the most significantly impacted by inflation. Target (TGT) said that “as supply grew and demand shifted from bigger, bulkier products like furniture, TVs and more […] we can make room for fast growing categories like food & beverage, beauty and personal care, and household essentials.”
Categories like luxury and beauty remain robust in conjunction with the re-opening theme – looking at results from Chanel, Ralph Lauren (RL) and Nordstrom (JWN). Now more than ever it is critical to do the fundamental analysis to understand the complexities of the consumer. There are pockets of strength, and we expect that to continue in the near term.
That said, we will be watching to see if higher wages are enough to maintain a strong consumer in the fall and into winter, assuming inflation remains hot. If we see a continued deceleration in appreciation across real estate and capital markets, consumers might lack a continued confidence to spend in excess or might not meet a spending capacity that offsets sustained inflation. We continue to see opportunities in both the re-opening theme and the trade down discussed above as well as the high end of the consumer, particularly the beauty, category.