Our entire consumer society has been built upon a foundation of lies. The biggest being you could get wealthy without saving. The other being that you were wealthy if you owned stuff that made you look wealthy. There are 1.5 million retailers in America. There will not be 1.5 million retailers in 2020. The winnowing of the chaff from the wheat has begun, but will accelerate over the next decade. The mom and pops are already closing up shop in record numbers. The shocking revelation that major mega retailers such as a Target or a Kohl's might not exist in ten years will not be believed today. Ever hear of Montgomery Ward?
What most people don't understand is that the mega-retailers' strategic plans were based upon never ending store growth, 5% comparable store growth for all eternity, a continuous flow of increasing easy credit, the American population staying frozen between the ages of 30 and 50 years old, and a delusional materialistic greed embraced by the masses. Mega retailers without growing comp store sales are like sharks that can't swim. They will die. The comp store sales growth is essential to overcome the effects of cannibalization from new stores. The CEOs of these companies have never modeled a decade of declining sales. They still believe it can't happen, even though it must happen. Delusions die hard, especially for CEOs.
I'll use Target as an example. Almost everyone would agree they have been one of the best run retailers of the last two decades. They have over 1,700 stores in the US, with annual sales exceeding $65 billion and profits of $2.5 billion. How could a retailer this large and successful ever go bankrupt? They have $16.5 billion of debt and $15.3 billion of equity on their balance sheet for a 52% debt to equity level. This is not a dangerous level, but it is a heavy debt load. The deterioration always begins on the sales side. Comp store sales have been deteriorating since 2005 and were negative in 2008 and 2009.
The impact of this sales deterioration can be seen in their net income over the last five years. It is at the same level as it was in 2005 and $361 million lower than 2007. Target opened 343 new stores between 2005 and 2009 and its net income is the same. Net income per store has dropped from $1.72 million in 2005 to $1.43 million in 2009, a 17% drop per store. In their peak profit year of 2007, they generated $1.79 million profit per store.
What most people don't know is that Target goosed their profits using the same method that Americans used to get "rich". EASY CREDIT. When you've run out of ideas to grow your business, offer easy credit to your customers. It worked like a charm for Target until it didn't. They issued millions of credit cards to the delusional masses. Who needed to sell stuff, when you could make so much lending money? In 2007, the Target credit card accounted for $1.06 billion of their $2.85 billion profit, or 37% of total profits. This was up from 22% of their profits in 2004. They've been learning a difficult lesson as credit card profits plunged to $400 million in 2009 as they desperately tried to sell their rapidly deteriorating portfolio with no takers to be found.
Annual Earnings Data 2009 2008 2007 2006 2005 Net Income (1,000à ‚¬ ²s) $ 2,488,000 $ 2,214,000 $ 2,849,000 $ 2,787,000 $ 2,408,000 YoY % Chg 12.4% -22.3% 2.2% 15.7% 27.7% Diluted EPS $ 3.30 $ 2.86 $ 3.33 $ 3.21 $ 2.71 YoY % Chg 15.4% -14.1% 3.7% 18.5% 30.9% Annual Store Operating Data 2009 2008 2007 2006 2005 Store Count 1,740 1,682 1,591 1,488 1,397 Store Sq Ft (1,000s) 231,941 222,588 207,945 192,064 178,260 Employees 351,000 351,000 366,000 352,000 338,000 Net Sales per Store (1,000à ‚¬ ²s) $ 37,075 $ 38,426 $ 39,929 $ 40,123 $ 37,908 Net Sales per Sq Ft $ 290 $ 301 $ 318 $ 316 $ 307 Net Sales per Employee $ 180,726 $ 175,409 $ 171,228 $ 167,762 $ 162,765The beautifully constructed staircase of store growth seen in the chart below has reached the top floor. If Target foolishly continues to build new stores while Americans ratchet up their savings and ratcheting down their spending, they will end up taking an elevator straight to the basement. The credit card fountain of profits is gone. Same store sales growth is gone. New market growth is gone. It's time to get real. The upper management of every retailer in America better pull out their little models and plug in declining consumer spending for the next decade. This will reveal the stores that won't cut it. They will need to close them based on profitability. Will this be done? Absolutely not. The hotshot CEOs will think a better advertising campaign will do the trick. Delusions die slowly.
Many might think I'm being overly pessimistic. I would contend that I've presented a best case scenario. I've completely ignored the implications of peak oil and $5 per gallon gas on mega retailers that require you to drive miles to shop at their stores and source all of their goods from thousands of miles away. Combine that with an ever declining USD that drives the prices of imported good higher and you have a perfect storm for retailers in America. I'm sure the scenarios I've presented will do wonders for commercial real estate and the banks that are on the hook for those loans.
In the immortal words of David Byrne, "the future is certain".
WELL WE KNOW WHERE WE'RE GOIN'
BUT WE DON'T KNOW WHERE WE'VE BEEN
AND WE KNOW WHAT WE'RE KNOWIN'
BUT WE CAN'T SAY WHAT WE'VE SEEN
AND WE'RE NOT LITTLE CHILDREN
AND WE KNOW WHAT WE WANT
AND THE FUTURE IS CERTAIN
GIVE US TIME TO WORK IT OUT
We're on a road to nowhere
Come on inside
Takin' that ride to nowhere
We'll take that ride
Feelin' okay this mornin'
And you know,
We're on the road to paradise
Here we go, here we go
Road to Nowhere Talking Heads
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