Tuesday, August 08, 2006

US retailers may face heatof summer slowdown

US retailers may face heatof summer slowdown
By Lauren Foster
Copyright The Financial Times Limited 2006
Published: August 8 2006 03:00 | Last updated: August 8 2006 03:00

Investors will keep a close watch on Target's quarterly earnings, due to be reported on Thursday morning, after Starbucks' weak July sales heightened concerns about a slowdown in US consumer spending.

Last week Target, the US discount retailer, reported same-store sales growth of 3.1 per cent - at the bottom of its reduced forecast of 3-4 per cent.

Starbucks, the world's largest speciality coffee chain, said July sales rose just 4 per cent - the smallest increase in nearly five years and at the low end of the company's long-term target for monthly same-store sales growth of 3-7 per cent.

When Target, which attracts a higher-income shopper than larger rival Wal-Mart, last month lowered its forecast for July sales, some wondered whether the slowdown was company-specific or a sign of a broader macroeconomic trend.

Those same concerns surfaced last week after Starbucks blamed sluggish July sales on heavy demandfor its cold, blended frappuccinos.

The "frappuccino effect", as one analyst dubbed it, went something like this - hot weather prompted more people to order blended drinks during the busy morning hours, which slowed service, createdbottlenecks and long queues, and drove away some customers.

Some analysts took a different view - that the dip in sales at stores open at least 13 months, a key measure of a retailer's health, suggested Starbucks' customers might be cutting back on discretionary spending amid the surge in energy prices.

John Glass, analyst at CIBC World Markets, said in a report that there was "some credibility" to the frappuccino effect "given the blistering July and the fact that we do not believe afternoon comp-sales have materially decelerated from recent levels".

But he added: "If this slowdown had come at any other time, we would have accepted this explanation without question. The problems is that it . . . came at a time of unprecedented slowing sales in restaurants. While the frappuccino is part of the problem, the larger issue is that as large as Starbucks has become it has also become mainstream, and therefore more subject to the vagaries of the broader consumer."

But Jim Donald, Starbucks chief executive, dismissed the notion that macro-economic factors were behind the sales numbers.

"We are not seeing any signs that macroeconomic trends are having a significant impact on Starbucks' business," he said during an earnings conference call.

However, he acknowledged that the company had stumbled in failing to anticipate the blended beverage demand, especially inthe morning, and said "the opportunity for improvement" was within itscontrol.

"We know it is not just our job to create customer demand through innovation, we also have to satisfy that demand and we are working to alleviate new capacity constraints that develop as our business grows," he said. Those measures include improving the equipment, better use of its employees and adding cold beverage stations.

David Palmer, analyst at UBS Investment Research, said the question was - how long would it take for Starbucks' adjustments to remove the bottlenecks?

"Some changes such as improved labour deployment and training can have an immediate benefit, while equipment changes will likely take longer," he told clients.

Don Gher, chief investment officer at Coldstream Capital Management, said the company would have to prove to investors that the mis-step in July was an anomaly. Starbucks was now a "show me type of stock", he said.

Investors will not have to wait too long, as Starbucks reports sales on a monthly basis. The August and September numbers would likely show whether the company's frappuccino explanation was credible, analysts said.

Still, the weak same-store sales raised a number of questions. "Is this the law of big numbers catching up with them? In other words, it takes much more in terms of sales through the system to move that comp-storeneedle. I don't think that's the case," Mr Gher said.

"Secondly, is it a macro-economic issue? All indications point to that not being the case, based on the overall sales and traffic. The US is in the midst of a heatwave, so their explanation sounds pretty logical."

The problem was the bottleneck created by demand for the cold, blended beverages. "The management team are straight shooters. I think they will address this."


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