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Elevated inventories place retailers in a 'promotional environment': Analyst

UBS U.S. Food Retail Analyst Michael Lasser joins Yahoo Finance Live to share what he's looking for in retail earnings reports this week, how retailers are dealing with excess inventory, and the impact of a potential recession.

Video transcript

SEANA SMITH: Well, we will get another look at how inflation is impacting consumer spending when we get a number of earnings results from retailers this week with big names, including Walmart, Target, Home Depot, Kohl's, TJX, among some of the big retailers that are set to report. Joining us now for what to expect we want to bring in Michael Lasser, UBS Hardline, Broadline, and Food Retail Analyst. Michael, it's great to see you. I guess, first, just what's the big thing you are going to be looking for in the reports this week?

MICHAEL LASSER: The big thing that we're going to be looking for in the reports this week will be how well is A, demand holding up, and B, how fast are these companies working through the excess inventory that they had coming out of the first quarter? This has been putting a lot of pressure on the profitability of the retail sector as these retailers have had to discount that excess inventory. So the faster they can get through that, the better it will be for their profitability.

DAVID BRIGGS: What do you expect we'll learn from the consumer and how they've been impacted by inflation?

MICHAEL LASSER: I think there's going to be a couple of themes. Number one, continued inflation in the price of consumable items, food, and household products has continued to crowd out spending that's been available for discretionary items like home, apparel, consumer electronics, sporting goods.

The second point is that depending on the income segment, spending's probably varying quite a bit. More affluent consumers have been feeling a little bit better about their situation. The lower and middle-income consumer has been feeling a lot more pressure, if only because those cohorts of consumers have not had as much support from government-- from the government stimulus this year compared to last year.

SEANA SMITH: Michael, we heard about inventory level concerns, promotional environment, namely from Walmart and Target. We're going to be getting those results this week. How do you think the setup looks like for the second half of the year? And should we expect more promotional activity?

MICHAEL LASSER: So it's best to expect that this is going to be a promotional environment because of all the inventory pressure, as well as the facts that are facing the consumer like the inflation, like some of the economic uncertainty. So we are anticipating that it's going to be a promotional environment. But once we-- since there's a better balance between the demand for inventory and then the availability of supply of inventory, some of that promotional activity is probably going to lessen.

And then the big question will be, what happens in 2023? And that's largely going to depend on what happens in the labor market given how strong the labor market has been. The best place-- the best way to look at it right now is with some guarded optimism. As long as jobs remain plentiful, wages continue to rise, consumers should be in a relatively good spot.

DAVID BRIGGS: Gas prices have come down quite a bit, $3.96 today. But how do you expect that high gas prices will really factor in, particularly with Walmart and Target this week?

MICHAEL LASSER: Well, I think you made the operative point, which is that there has been almost five to six weeks in a row of gas prices coming down. The price of the underlying commodity is down 5% today. So that's going to provide some relief to the consumer.

With that being said, as you pointed out in your prior segment, the price of a lot of other necessities remains high, like food costs. Shelter and lodging costs remain quite high, so the consumer still facing a lot of pressure. And we're going to see that most likely featured in the results of Home Depot-- excuse me-- Walmart and Target, where consumers are having to rely on these discounters as a way to stretch their budgets because they're under so much pressure.

SEANA SMITH: Michael, Walmart and Target's stock prices have really been under pressure, Target off just about 25% year-to-date. Walmart is also in the red this year. What do you think has already been built into these stocks?

MICHAEL LASSER: I think what's built in these stocks is that a lot of the margin pressure that these companies have been experiencing this year will persist into next year. We don't agree with that view. We think once they get through some of the excess inventory that-- both companies have experienced significant margin expansion over the last couple of years.

And that's due, in part, their store volumes are higher because people have been at home. They've been relying on these retailers. These retailers have been gaining market share as consumers consolidate trips.

And they've been able to leverage their fixed expenses with higher sales volumes. Those factors should be more evident next year, assuming that there's just not as much discounting. And so we don't agree with the idea that a lot of the margin pressures that have been present this year will persist into next year.

DAVID BRIGGS: Michael, we'll also get earnings from Home Depot and Lowe's. And given builder sentiment fell for an eighth straight month, what are your expectation for those two?

MICHAEL LASSER: I think there's been a disconnect between the underlying housing market and the way the consumer looks at investing in their home. The instances of working from home are still very high. And that's allowed for more time to do those home improvement projects, to plant a garden, paint a room, fix some items that have been broken because of more wear and tear on the home.

In addition, many consumers are-- are struck in a mortgage rate that's well below where the prevailing rates are in the market right now. That creates less of incentive to move and more of an incentive to stay put. And if consumers are staying put, that means they're more inclined to make some home improvements in their house. So we think that what the results of Home Depot and Lowe's are going to show is that the consumer remains very engaged within the home improvement sector.

DAVID BRIGGS: Yeah, see, Michael, I had to return to the office, that's why I'm not able to improve the home. That's just-- just telling my wife, you know what I mean?

MICHAEL LASSER: Yeah, right.

DAVID BRIGGS: That's the only reason. Michael Lasser--

SEANA SMITH: That's the only thing that's keeping you from doing it?

DAVID BRIGGS: It's the only reason for my repairs not happening. Michael Lasser, good to see you. Thank you.