Fiscal Responsibility Is Killing Retail

Want to sum up the economic crisis in a single word? Try "excessive."

Recklessly spending consumers tapped home equity, maxed out their credit cards, and whittled down their savings rate to negative levels, all to purchase items that were unaffordable from any realistic perspective. The trend was a ticking time bomb, but retailers got caught up in the moment.

Much like homebuilders such as Toll Brothers (NYSE: TOL  ) , the retail sector capitalized on the aspirational consumer -- a category that emerged throughout the last several years of excessive lending and spending. Starry-eyed retailers saw opportunity to achieve extraordinary growth, and they began expanding at unsustainable rates.  

A new era of frugality
But the spending bubble has exploded. In response to the recession, consumers have cut back on spending and begun saving. As of January 2009, the personal savings rate rose to 5% of disposable income.

From a long-term economic standpoint, this is welcome news. However, it has created a significant mismatch in the supply and demand for material goods. While fiscal responsibility may be a temporary response to the economic downturn (and temporarily detrimental to the economy), I believe it is vital for our economy's health in the long run. Hopefully, consumers learned a hard lesson from their past mistakes and will continue to save in the future.

But if they do, what will that mean for the retail sector?

The retail graveyard grows larger
Many retailers endured a painful 2008. Several companies declared bankruptcy, while plenty of others visibly struggled. If consumers continue to cut back on spending, I predict we will see the same pattern on an even grander scale over the next several years. The supply of consumer-oriented goods must readjust to new consumption levels, so that supply and demand can reach a new equilibrium. Retailers that either overexpanded or exposed themselves to financial weakness will be the least likely to escape the recession as solvent entities. 

My Foolish colleague Alyce Lomax has already listed retailers whose unhealthy balance sheets earn them a place on her retail death watch. Here, I'd like to focus on companies that may appear financially sound, but are at risk because of their overexpansion.

Bag it and tag it
I consider Coach (NYSE: COH  ) a perfect example. As a business that sells luxury accessories, its target audience should be upper-middle-class women -- a segment that isn't really large enough to support high long-term growth rates. The company should have expanded more cautiously, to preserve brand reputation and avoid oversaturating its market. Coach did exactly that with great success for decades, but the company lost its focus during the consumer spending fury that followed the tech bubble.

Coach Metrics

FY 2002

FY 2008

Store Count

297

548

Sales

$719 million

$3.18 billion

Source: Coach annual reports.

Founded in 1941, Coach took more than 60 years to build 297 stores. Throughout this period, carrying a Coach bag became a symbol of financial success for women. In the middle of 2002, it still wasn't even generating $1 billion in annual revenue, but it was a prosperous company that sold a rock-solid brand.

Six years later, Coach had almost doubled its store count, and its revenue had risen at a 28% annual clip. This was made possible by the company's masterful techniques at selling to aspirational consumers. Average shoppers who previously could never have afforded a $200 purse had access to easy credit, and they took the opportunity to "peek" over the wall that separated the wealth from the average. This made Coach look like a smashing success. The stock price followed suit, providing more than tenfold total returns from the beginning of 2002 until the shares peaked in April 2007.  

Adios, aspirations
Today, those shoppers are gone -- and even if a few stragglers are left, American Express (NYSE: AXP  ) is paying them $300 apiece to cut up their cards. Companies like Coach that chased after this special category of shoppers are now stuck with large empires they rapidly built during the last several years, even as they face a greatly diminished target market.

In my opinion, many of these companies will have no choice but to eventually scale down operations to meet fiscally responsible consumers' new, lower demand levels. In many cases, they won't be able to escape marking down prices, either. Starbucks (Nasdaq: SBUX  ) , the epitome of overexpansion, is currently reducing its store count, and it recently began offering breakfast combo deals -- a move that signifies that its core audience is changing,

Bottom line
Like the rest of this financial crisis, the retail sector's overexpansion has been a reminder to buy-and-hold investors that seeking quick profits and explosive growth isn't always prudent in the long run. Instead, investors should look for companies like Buckle (NYSE: BKE  ) , Urban Outfitters (Nasdaq: URBN  ) , and Nordstrom (NYSE: JWN  ) , where management meticulously plans out growth instead of capitalizing on short-term trends.

Further Foolishness is in the bag:

Coach and Starbucks are Stock Advisor selections. American Express and Starbucks have been recommended by Inside Value. The Fool owns shares of American Express and Starbucks. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Kristin Graham owns shares of Starbucks, but now regrets the purchase. The Fool has a disclosure policy.


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  • Report this Comment On March 11, 2009, at 2:47 PM, p2i wrote:

    You imply that Coach started as a retailer. It started in 1941 as a manufacturer of men's wallets. The first store was opened in 1982. Between 2004 and April of 2008, it had opened only 94 new full priced locations: fewer than 22 per year on average. It also opened dozens of discount outlet stores at the same time. These outlet stores do not sell the same products; they sell mostly different lesser priced products. Accoring to the latest 10Q, store count in North America is now 324 retail stores and 106 factory stores (outlet stores) . The rest of the store count is international locations. That doesn't constitute oversaturation in my hubble opinion.

  • Report this Comment On March 11, 2009, at 2:51 PM, p2i wrote:

    Sorry about the poor spelling. Accoring should be according and hubble should be humble.

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