Strategic Profit Model Results for 2010

John S. Strong & Lawrence J. Ring
As in past years, we have updated our review of Strategic Profit Model results for retailers for 2010. After a four-year period of dealing with financial crises and a deep, prolonged recession, retailers seem to finally have worked through adjustments to their business operations and seem to be regaining and strengthening financial performance.

U.S. Retailers

As we reported last year, the United States’ retail experience since 2007 has been challenging at best. The softening economy that began in mid-2007 initially was felt most significantly by retailers tied to housing and to consumer discretionary purchases, such as furniture, home improvement, and appliance and electronics businesses, were especially affected. The weak economy by mid-2008 began to affect more retailers. The financial crisis in September 2008 led to the stunning crash in retail performance in the fourth quarter of 2008. By 2009, retailers realized that they needed to revise not only their forecasts, but to cut back on inventories, capital spending, and operational expenses. In effect, the economic downturn forced retailers toward a different model for generating returns. The model of the early 2000s was built around sales growth, fixed-cost leverage, and substantial use of debt to generate high returns on equity. The changed economic environment requires a strategy of profitability based on productivity, not growth. It also requires more emphasis on returns on capital, as markets have much more conservative views about the appropriate level and potential consequences of high leverage.
Overall, 2009 represented a year of adjustment and transition for retailers. The effects of this restructuring were apparent in the 2009 results. Profitability and productivity improved a bit from the 2008 declines, but more so from cost adjustments than from recovering sales or productivity improvements. In 2009, the best performing companies reporting increases were overwhelmingly strong value-based retailers. The most significant improvements were made by those retailers who attempted to adjust their business models to the weak economic conditions, by reducing costs, adjusting merchandise mix, lowering prices, and discounting more. 
table1.jpgThe 2010 results, though, suggest that the efforts of the last three years are bearing fruit. Table 1 shows the Strategic Profit Model results for 2010 for the 74 largest public U.S. retailers, based on sales. Sales for these companies all exceed $2 billion. The companies in Table 1 had sales of $1,574 billion in 2010, a 3.5 percent increase from 2009. Their profits of $53.1 billion represented a 19 percent increase in net income, as Return on Sales grew from 2.83 percent in 2009 to 3.26 in 2010. Asset productivity (Sales: Assets) which had risen in 2009, was unchanged at 2.01. The combination of Return on Sales and Asset Turnover resulted in an increase of Return on Assets from 5.7 percent in 2009 to 6.6 in 2010.
After declining the past two years, financial leverage (Assets: Equity) rose slightly to 2.40 from 2.34 times. Overall, Return on Equity for the group rose from 13.3 to 15.7 percent—the first rise after three years of decline. Looking beyond the aggregate results, profitability (returns on sales, assets, and equity) increased for 52 of the 74 companies, indicating that improved performance was broad-based. 
At the individual and sector level, there were mixed stories in 2010. In specialty apparel and softlines, Limited Stores reported strong sales and profitability gains. Abercrombie & Fitch, in the wake of three years of losing share to other more value-oriented competitors, saw a strong recovery—sales were up 18 percent with improved return on sales, while Aéropostale posted smaller gains, and American Eagle was flat. Gap continued to post gains; its turnaround plan has brought good results now for three years running.
Value retailers continued to report strong results. While Wal-Mart sales grew only by 3.3 percent, this still represented a $13.6 billion increase for the world’s largest retailer. Wal-Mart posted a 5 percent increase in Return on Equity, achieved through its second consecutive year of increased Return on Sales (which rose from 3.34 percent in 2008 to 3.51 in 2009 and 3.89 last year). Financial results were especially good at TJX, Ross, Family Dollar, and Dollar Tree (which reached $5 billion in sales for the first time). In broadline retailing, Nordstrom continued its strong performance while Macy’s showed signs that its turnaround and restructuring plan was gaining traction. In contrast, JCPenney’s results were flat, and Sears Holdings continued its secular decline. In specialty retail, strong sales and profit growth were shown by Tractor Supply, PetSmart, Sherwin-Williams, and Bed Bath & Beyond.
In technology, Best Buy and the office-supply companies continued to face strong competition from Amazon, which saw a 40 percent increase in sales with only a small decrease in net margin. Staples finally saw improvements in both sales and profitability, while both Office Depot and OfficeMax continued to struggle.
table2.jpgIn food, higher- and lower-end players did well, while the mid-market continued to turn in weak results. Although Kroger and Safeway both reported improved results, Supervalu, Weis, Winn-Dixie, Spartan, Ingles, Ruddick, and A&P saw sales and profits flat to down.
Beyond the largest retailers shown in Table 1, this year, we also want to provide information about mid-market specialty retailers with sales of more than $250 million. Table 2 presents strategic profit model results for 2010 for a range of sectors. Many of these companies have world-class results (see list at the end of this article).

Still Struggling

In the midst of these generally better results, many retailers—including some giant, iconic names—continue to struggle and face uncertain prospects at best. On this list, we would include not only Blockbuster and Barnes & Noble, but also Sears, Office Depot, Charming Shoppes, Pacific Sunwear, Trans World Entertainment, and Zales.  

International Retailers

table3.jpgTable 3 reports similar results for a group of major international retailers. In contrast to the U.S .retailers, 18 of the 30 retailers in Table 3 experienced declines in Return on Equity, driven principally by lower profit margins, lower asset productivity. and lower levels of leverage. For European retailers, the financial and economic problems from the euro have started to show the same effects on retailers seen in the U.S. in 2007–2009.     
The growing euro crisis began to have some effect on retail. The European food chains generally saw lower returns on equity, slow growth, and flat to slightly down returns on sales. However, the faltering performance of Tesco and Metro in recent years appears to have stabilized. Carrefour continues to struggle with weak results and the effects of a series of strategic restructurings. Japanese retailer Daiei again experienced major losses; indeed, the largest Japanese retailers continue to post weak results.   
The top spot on the list is again held by Dairy Farm Group, part of Jardine Matheson, which operates food, pharmacy, and hypermarket formats in Asia. Dairy Farm reported improved return on sales, slight declines in asset productivity and return on assets, and a decrease in RONW due to reducing its high financial leverage. 
H&M and Inditex (Zara and other brands) continued their strong performance in the fast fashion segment, with each showing year-on-year improvement. H&M showed improved Return on Sales and better asset productivity. Inditex grew sales faster, albeit at lower levels of profitability and productivity than H&M did. 

Best Performers for 2010

Our selections for best performing publicly-traded retailers are:
Best Upscale Department Store: Nordstrom
Best Discount Department Store: Wal-Mart
Best Online Retailer: Amazon
Best Off-Pricer: TJX
Best Extreme Value: Dollar Tree, Family Dollar
Best Specialty Apparel: H&M, Inditex
Best Consumer Electronics: Best Buy
Best Pet Supply Superstore: PetSmart
Best Home Improvement: Home Depot
Best Supermarket: Publix
Best Pharmacy/Drug: Walgreen’s
Best Home Retailer: Bed Bath & Beyond
Best Office Supply: Staples
Best Specialty Other: Advance Auto Parts
Rising Stars: Tractor Supply, Ross
Best Turnarounds: Limited Brands, Gap
Biggest Challenges: Supervalu, Sears
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