February 2017 | By: John S. Strong and Lawrence J. Ring

Estimated reading time: Estimated Reading Time: 9.5 minutes

Key Takeaways

  1. Through acquisitions and restructuring, private equity has played a significant role in reshaping the retail industry over in 2015.
  2. Seven U.S. retailers had more than $88 billion in revenues in 2015. Among them, Amazon’s 20.2% increase in sales represented the most explosive growth.
  3. European economic problems and the continuing slowdown in China made 2015 another tough year in international retail.

As in past years, we have updated our review of Strategic Profit Model results for retailers for 2015.* After retail appeared to gain sustained traction in 2014, growth tapered off and new questions started to arise in 2015. There were fewer “star” performances than in recent years, as some turnarounds faltered and some recent star companies and sectors lost a bit of luster.

The 2015 results also showed mixed results across consumer segments, retail formats, and within individual retail sectors. Perhaps the biggest change in retail over the past year was the role of private equity in reshaping the entire retail landscape, through acquisitions and restructurings. These deals included the acquisition of PetSmart by BC Partners; Belk Department Stores by Sycamore Partners; Safeway (combined with the prior Albertson’s deal) by Cerberus Capital); and the spinoff of the Circuit City, CompUSA, and TigerDirect brands to PCM investors. These restructurings also spurred other deals, including the acquisition of Family Dollar by Dollar Tree, of Joseph A. Bank by Men’s Wearhouse, and Pantry convenience stores by Circle K/Alimentation Couche-Tard.

U.S. Retailers

Table 1 shows the Strategic Profit Model results for 2015 for the 63 largest public U.S. retailers, based on sales. Sales for each of these companies are approximately $2.5 billion or greater, and represent about 60% of U.S. domestic retail sales excluding motor vehicles.

Table 1 ranks this group based on Return on Sales. For our overall set of 63 U.S. retailers for whom both 2013 and 2014 results are available, the aggregate numbers remained positive with sales up 2.6% but with profits up only 2.0%. This is a significant slowing from 2014, when sales rose 7.5% and profits grew 8.4%.

Return on Sales (ROS) fell slightly to 3.35% in 2015 from 3.38% in 2014. Asset productivity (Sales:Assets) remained the same at 1.99. As a result, Return on Assets (ROA) fell slightly to 6.69% in 2015. In comparing Leverage and Return on Equity (ROE or RONW), accounting for negative equity due to share repurchases is required. If you exclude retailers with negative equity due to share buybacks, Leverage (Assets:Equity) rose slightly in 2015 to 2.79 from 2.73, and ROE rose to 18.4% in 2015 from 18% in 2013. In sum, sales and profit growth slowed, margins declined, asset productivity remained the same, leverage increased slightly, producing lower ROS and ROA, but higher ROE. Looking forward, margin pressures and rising interest rates will limit future leverage related gains, so retailers will need to look again at productivity as the driver of returns.

This slowdown in performance was apparent in the results for individual companies which were much more of a mixed bag. While 40 of the 63 retailers showed sales increases, only 33 reported increases in net income. As a result, only 26 of the 63 retailers reported increases in Return on Sales. As in recent years, this indicates that overall retail profit growth was driven by a much smaller subset of companies. Half of the $64.7 billion in retail profits in Table 1 are produced by just five of the 63 companies; 80 percent of the net income comes from just 15 of the 63 companies. On the other end, seven companies reported a combined net loss of $3.9 billion in 2015, led by Sears’ staggering loss of $1.13 billion—more than $300 million worse than last year’s record loss of $802 million.

Table 2 ranks these companies based on Return on Equity, along with the ROE results for the past five years. Most of the companies at the top of the ROE tables have shown consistent results over the past five years, including Home Depot, TJX, Ross, PetSmart, Tractor Supply, and Nordstrom. For 2015, Sherwin-Williams had the highest ROE. The company had reported among the best ROE in past years, but the 2015 ROE results were further boosted by a large share repurchase which reduced equity dramatically.

The Big Gorillas

Seven U.S. retailers had more than $88 billion in revenues in 2015: Walmart, Costco, Kroger, Amazon, CVS Health, Walgreens Boots Alliance, and Home Depot.

The most significant result continues to be the explosive growth of Amazon. Sales grew 20.2% in 2015 to $107 billion. Of that total, electronics and general merchandise accounted for $75.5 billion, while media ecommerce (Kindle ebooks, etc.) totaled $22.5 billion. Overall, Amazon accounted for 60% of total ecommerce growth in the U.S. in 2015. Amazon’s business model continued to evolve, with new business units of North America, International, and Amazon Web Services (AWS). Financial performance was markedly stronger, as net income rose and turned positive to $596 million. Operating profit rose from $178 million in 2014 to of $2.2 billion in 2015. AWS has become the most profitable and fastest-growing business unit; in 2015, AWS reported segment income of $1.8 billion on $7.9 billion of revenues. AWS generates two-thirds of the operating profit of North America retail segment on just over one-tenth of the sales. The international segment has slowed (in relative terms) and now is only 30 percent of Amazon revenues, and operates essentially on a break-even basis as a whole.

Amazon’s CEO, Jeff Bezos, has clearly and consistently stated that the company’s growth strategy is long term and that the most important financial metric for Amazon is free cash flow. Amazon’s operating cash flow exploded from $6.8 billion in 2014 to $11.9 billion in 2015. Unlike recent years, though, even continuing heavy capital expenditures meant that free cash flow reversed course, from a deficit of $2.2 billion in 2014 to a surplus of $2.5 billion in 2015. Amazon also built up substantial cash on its balance sheet, ending 2015 with just under $20 billion—a 50% increase from two years earlier. Amazon’s challenge to existing retailers continues to grow.

Walmart, the world’s largest retailer, reported its first drop in total revenue to $482 billion, a 1% decrease. (It is worth noting that if the U.S. dollar had not strengthened during the year, Walmart revenues would have been $17 billion higher.) Rising labor costs and competitive pressures resulted in a drop in profit margin to 3.05 from 3.19%, which translated into lower returns on capital and equity. Costco saw significant sales and profit gains, while Kroger saw slower revenue growth but better margins. CVSHealth continued to report better sales growth and pharmacy results than Walgreens, which has added a proposed Rite-Aid acquisition as well as continuing integration with Alliance Boots. Home Depot and Lowe’s both saw strong revenue growth, but with softening margins and returns. Increases in Return on Equity for both Home Depot and Lowes were driven by share repurchases more than by higher margins.

Sector Results

Financial results were especially strong at off-pricers and deep discounters TJX, and Ross. TJX reported its eighth straight year of Return on Equity above 40%, and fourth year above 50%. Ross’s ROS continued to be higher than TJX, and it also reported its sixth straight year of ROE greater than 40%. In the dollar extreme value segment, Dollar Tree almost doubled in size from its acquisition of Family Dollar, but saw profitability fall as the acquisition was implemented. Dollar General, who lost the bidding war for Family Dollar, reported strong sales gains with sustained returns.

In U.S. specialty apparel and softlines, Aeropostale went bankrupt, while Abercrombie & Fitch and Gap continued to struggle. The only bright spot was American Eagle, which continued its sales and profit turnaround. In broadline retailing, Nordstrom still had the best performance, albeit with declining margins. The department stores produced poor results. Both Macy’s and JC Penney saw significant declines in revenues and profitability. Kohl’s saw declining margins and productivity, with flat sales. Sears’ performance was again terrible; the company is now half the size of the combined Sears and Kmart at the time of the merger in 2005. In the past five years (January 2011-Januray 2016), Sears has lost $8.2 billion, and its stock price has fallen 59% versus a 21% gain for the U.S. department store index.

In technology, Best Buy and the office supply companies continued to face strong competition from Amazon. The long-term strategic problems of Staples and Office Depot/OfficeMax accelerated, as their proposed merger fell apart. The companies again reported declining sales and weak results overall. In specialty retail, strong sales, profit, and return performances were shown by Tractor Supply and especially by Ulta Cosmetics. Also notable was the continued strong performance of the leading automobile parts retailers AutoZone and O’Reilly Automotive, although Advance Auto Parts continued to show results much softer than the two leaders.

In food retailing, the results were again mixed, with a range of performances across all customer segments. Publix again reported continued strong results. Kroger continued to make progress in becoming America’s largest supermarket chain through additional acquisitions. Safeway’s faltering turnaround led to its takeover by private equity, while Supervalu, Spartan, Weis, and Ingles continued to struggle.

International Retailers

European economic problems and the continuing slowdown in China made 2015 another tough year in international retail. Table 3 reports similar results for a group of major international retailers. Only 11 of the 27 retailers in Table 3 experienced increases in Return on Equity, and some these increases were quite small.

The top spot on the list is held by H&M, whose 36% return on equity was the 10th straight year in which ROE exceeded 35%. H&M and Inditex (Zara and other brands) continued their strong performance in the fast fashion segment. Fast Retailing (Uniqlo) saw a drop-off in performance as growth challenges and weak American performance hurt results.

For European retailers, the financial and economic problems from the soft economy continued in 2015. Competitive pressure from hard discounters Aldi and Lidl continued as a major challenge to European food retailers, with softer results at Ahold and Delhaize spurring the two companies to merge to reduce costs. The performance of Tesco, Morrison’s, Metro, and Walmart’s U.K. Asda unit also continued to be soft. Woolworths Australia saw dramatically worse results; rival Wesfarmers were better, but still off from 2014 performance. Carrefour’s series of strategic restructurings appears to stumble again. Japanese retailer Daiei again experienced major losses. The largest Japanese retailers continue to post weak results, with the notable exception of Seven-Eleven Japan, which continues to be the world’s premier convenience store chain.