Sunday, September 21, 2014

The way animals quiet and birds flee before natural disasters hit, professional investors months ago presciently cut their exposures to American retailers. Now, a man-made tsunami rushes toward the sector that will crush overleveraged vendors, landlords and communities across the country.

In recent weeks, the unholy alliance between the “say anything” wing of the Democrat Party and the “investigate nothing” cadre in the mainstream media has fallen on the sharp rocks of indisputable fact concerning the progress of incomes inside America.

Though speakers such as first lady Michelle Obama continue to protest otherwise, data released Sept. 9 by the federal government show that the engine of America’s economy is actually racing in reverse — after-tax incomes, on a per household basis, plunged 11.1 percent from $63,370 in 2012 to $56,352 in 2013.

More significantly, each quintile of American households experienced declines in after-tax income.

The top 20 percent of earners suffered a 15.2 percent decline from $158,024 down to $134,044. The next quintile experienced a 9.0 percent decline from $73,970 to $67,344. The middle quintile dropped 7.8 percent from $46,777 to $43,592. The next lowest group dropped 3.5 percent from $27,743 to $26,764. And, the lowest quintile dropped 0.8 percent from $10,171 to $10,092.

Suppressing benchmark interest rates, pressing banks to lend and running record government deficits have not offset structural pressures upon after-tax incomes in our country.

SEE ALSO: U.S. incomes flat for second year in a row — Census

Households whose incomes are under siege are not likely to increase the pace of their spending, leaving aside concerns most have about the level of total debt that is already piled high upon the American economy.

The trouble coming soon for retailers

Each year, the period from late November through January is crucial for retailers.

Praying that the kind of violence seen at Westgate Mall in Kenya last year does not occur here during this key selling season, experienced retailers must be extra anxious considering the substantial and unwelcome contraction in estimates of household income.

Unless an epidemic of peace breaks out — highly unlikely given numerous intractable geopolitical contests — a tougher credit environment coupled with more-expensive energy spells even more doom for traditional retailers as they contemplate how 2014 will close.

This year and for years to come, shoppers will find it easier and easier to evaluate and purchase most merchandise online. Moreover, as the senior cohort grows relative to the number of economically active persons aged 25 to 54, the complexion and size of consumer demand will weaken and become even more price conscious.

Should U.S. interest rates ascend towards levels seen between 1964 and 1999 — retailers will be pounded harder than the city of Detroit.

Which ones could suffer most?

Key metrics for American retailers

Investors should always do their own homework, especially reviewing public filings found on SEC.gov.

The largest American retailer, Wal-Mart Stores, generated $476.3 billion in total revenues during its most recent fiscal year. Out of this massive sum, the company only collected 2.3 cents in “free cash flow” (operating cash flow less capital expenditures) for each dollar in revenue in its most recent fiscal year — a thin margin of safety. Moreover, because its work force of 2.2 million is so large, the company generated less than $5,000 in free cash flow per employee.

Down 5.4 percent since peak trading levels in December 2013, Wal-Mart has an enterprise value (market value of equity plus total debt less cash) of $295.6 billion, an amount that is a lofty 27 times free cash flow ($10.9 billion).

To reach your own conclusions, calculate these key ratios for other well known American retailers including such household names as Tiffany and Sears. What you discover may prove surprising.

Marc Faber is absolutely correct in noting there are “bubbles everywhere” — this is definitely true in late September 2014 in retailing.

Charles Ortel serves as managing director of Newport Value Partners (NewportValue.com), which provides economic research to executives and to investment firms.

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