There’s been discussion about consumers spending less this winter shopping season, and how the credit crisis is the culprit. I would like to introduce a thought here, and one that extends a little further down the rabbit hole. Consider for a moment that demand destruction has in fact occurred. Consumers are scared and are holding back purchases – everyone understands that concept. However, the new construct I would like to introduce is the notion that demand destruction will not exceed supply destruction.
What did that mean exactly? Most retailers, specifically consumer focused retailers, tend to turn profitable around Thanksgiving. That’s one of the reasons why the day after Thanksgiving is called Black Friday. This is directly tied to demand coming in the front door (actual or virtual) of the business. It’s possible that the exogeneous factor of the credit crisis may delay Black Friday, and in fact keep the year in the red. However, if one also considers the reduced ability to borrow, things get even more challenging for the retailers to turn profitable.
Retailers need to stock up inventory ahead of their selling season. Inventory is taken on credit terms. Whether it’s a “net X day” payable, with the ability to return the goods if unsold, or borrowing against the value of the inventory is irrelevant. Someone, somewhere, needs to borrow funds to make the stuff. If the ability to borrow is impacted, whether by higher interest rates (pushing down margins and borrowing power), or borrowing is negated all together, the retailer themselves will be harmed because they will have reduced inventories to sell. With reduced inventories, retailers will be challenged to hit their “black” date.
This puzzle becomes ever more challenging when you consider psychological factors on pricing. To wit, if retailers fear reduced demand, they may start jumping the gun and offering sales, at reduced prices (and thus reduced margins), to spur demand. This will have the perverse effect of pushing out even furhter the date at which they would turn black. An even bleaker picture could envision inventories running out, and credit not being there to keep up with even a reduced demand, at reduced margins.
I can say this – I would not want to be long any retailers for the next two quarters.