Retail earnings have never been better, but the delta variant remains the wildcard.

In theory, this is a golden moment for retailers, which begin reporting earnings this week.

Consider the following:

The consumer is flush. The American consumer has never had more disposable cash or more leisure time than in the past year.

There’s commodity inflation, but most retailers can pass on the higher costs. Because the consumer is flush, there is less resistance to higher prices.

There’s a supply/demand imbalance. Demand for most goods is high, but supply is low because supply chains have been interrupted. Inventories are low.

There’s very little on sale. Retailers can sell more goods at full price. That helps profit margins.

The market is trading up on the narrative that the economy will keep opening up, but the delta variant means consumer behavior could change quickly.

The key test is back to school. A strong back-to-school season is good for retailers, and usually implies good holiday sales. Look to the south, which has an early opening.

Two key questions as retailers begin to report earnings:

What is the trajectory from 2019 to 2022? 2020 is not a good comparison year; investors will want to know how 2022 is going to stack up against 2019.  

Can margins stay high? Higher revenue and lower costs have significantly improved margins, but inflation may be a bigger headwind than some expected.   

For Joe Feldman, who follows retail as senior managing director at Telsey Group, this is the biggest issue: “The consumer is ready to spend, but I am worried about the cost side of things,” he told me. “They are nervous due to freight expenses and labor costs. How much can they pass on?”

The big winners in the retail sweepstakes this year are the trio of “super sellers” (Walmart, Costco, Target).  Consumers know they can get almost everything they need at these three retailers, and they are likely taking market share from others.  Sporting goods, and a small group of specialty retailers have continued to benefit from athleisure and at-home (Lululemon, Crocs, Deckers).

Retail “super sellers”
(YTD)
Target   up 48%
Costco  up 19%
Walmart   up 4%

Other sectors to keep an eye on include the following:

Home improvement: The “peak demand” theory — that home improvement has peaked now that more people are going out — makes sense, but traffic still appears strong at Home Depot and Lowe’s. Lumber inflation that helped Lowe’s and Home Depot in the first quarter will not be a help now. The delta variant may or may not force more people to stay at home.

Home furnishings — winners so far: Ethan Allen and Williams-Sonoma are significantly outperforming the broader market, but are off their highs earlier in the year. 

Grocery stores: They gained during the pandemic, but how much of business did they retain? Grocery Outlet recently gave disappointing guidance. Is business more transitory than expected? 

Department stores: Clobbered last year, but too early to say whether they are bouncing back. Macy’s and Nordstrom were big movers in the first quarter and have essentially been sideways since. To the extent delta slows the recovery of the economy, that is a negative for malls.

Department stores
(YTD)
Kohl’s   up 35%
Macy’s  up 70%
Nordstrom   up 17%

Clothing/cosmetics — a real wildcard. The delta variant is coming at bad time for back to school. The bull case was that once everyone was vaccinated, everyone would go out and buy clothes and cosmetics. But the variant has cast doubt on that: Is everyone going to that indoor wedding? Is everyone refreshing their wardrobe for back to work? Or going back to social activities? The delta variant has made everyone less certain about their work plans, and their social plans. The immediate need to replace that wardrobe may be lessening. One bright sign: Cosmetics giant Ulta Beauty has been a recent outperformer.

Apparel
(YTD)
Urban Outfitters   up 50%
UnderArmour  up 45%
Gap                     up 45%
Capri Holdings  up 42%

Specialty Retail
(YTD)
Best Buy             up 14%
Ulta Beauty         up 28%
Signet Jewelers  up 151%
AutoNation            up 66%

Bottom line: There was a lot of optimism in the first quarter. That will continue, but it will likely be tempered.

“Second-quarter numbers will be fine, but they will likely be more cautious about the second half of the year.  The delta variant may delay the recovery.” Telsey’s Feldman told me.