Strategic Profit Model Results for 2018

By John S. Strong & Lawrence J. Ring

As in past years, we have updated our review of Strategic Profit Model results for publicly traded retailers for 2018.* The main theme of 2018 was profitless growth. Topline retail growth was achieved only through aggressive price competition and lower margins - which has become a recurring theme in recent years. This profitless growth was even more surprising in 2018, as many retailers benefited from the reduction in corporate tax rates.  Retailers continued to grapple with the full financial consequences of online, digital, and omnichannel operations, both from investment and competitive standpoints.  Similar to the past few years, we observed fewer “star” performances, as some turnarounds faltered and some recent high performers fell away.  The 2018 performance also shows mixed results across consumer segments, retail formats, and within individual retail sectors. Private equity, restructurings, and consolidation continued to reshape retailing; notable transactions in 2018 included the bankruptcies of Sears, MattressFirm, and Claire’s.  Merger and acquisition activity slowed from 2017.

U.S. Retailers

Table 1 (pdf) presents the aggregate Strategic Profit Model results for the 53 largest public U.S. retailers, based on sales. Sales for each of these companies are at least $2.5 billion (or more), and represent about 60% of U.S. domestic retail sales (excluding motor vehicles).  For our overall set of 52 U.S. retailers for whom both 2017 and 2018 results are available, the aggregate numbers were striking, with sales increasing 6.7% to just under $2.2 trillion, but profits were only up 0.4% to $68.3 billion.  As a result, Return on Sales (ROS) fell to 3.12% in 2018 from 3.32% in 2017 (and from 3.62% in 2016). Net profit margins have thus fallen by a full half-percentage point in just two years, representing over $10 billion in lost profits. As discussed below, Amazon had the largest effect on these aggregate results.  Amazon’s revenue growth of $55 billion was almost 40% of the total, yet its $7 billion of increased profits was only 2.3% of the sector’s profit growth.  It is clear that Amazon continues to drive industry revenues while simultaneously pressuring profitability.  

Asset productivity (Sales:Assets) fell from 1.98 to 1.84.  As a result, Return on Assets (ROA) fell from 6.58% to 5.76%.    Continued low interest rates and share repurchases led to a slight increase in Leverage (Assets:Equity) from 3.27 in 2017 to 3.42 in 2018. (This is a continuing trend, as Leverage for this group was 2.73 in 2013.) In aggregate, Return on Equity (Net Income:Equity) fell to 19.7% from 21.5% a year earlier.  Thus, except for sales, the aggregate numbers and returns for the largest publicly traded US retailers went backwards again in 2018, as they had in 2017.

Table 2 (pdf) shows the individual results for 54 retailers, ranked by Return on Sales.   At a disaggregate level, variations in performance are striking.  While almost 80 percent of the retailers (41 of 52) retailers achieved sales increases, only 30 of 52 were able to increase net income.  Overall, 29 companies had increases in Return on Sales, 37 had increases in asset productivity, and only 37 retailers had increases in Return on Assets.  Any asset productivity increases were typically quite small and not enough to offset margin declines.  Twenty-eight companies had higher leverage.  Taken together, only 29 of 52 retailers had a higher return on equity, and ten of those only did so by increasing leverage. 

Table 3 (pdf) ranks these companies based on Return on Equity, along with the ROE results for the past 5 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, Tractor Supply, Ulta Beauty, Sherwin-Williams, and Nordstrom, although part of the high ROE results for Home Depot, Nordstrom, AutoZone, and O’Reilly Auto Parts were the result of large share repurchases which reduced book equity values (in some cases to negative values).

As a result of extensive share buybacks, ROE has become less helpful as a performance metric.  This was especially true in 2018, as many retailers used the benefit of lower taxes and higher cash flows to accelerate repurchase programs.  Because of this effect, Return on Assets has become a more meaningful comparative measure.  Table 4 (pdf) shows the rankings based on ROA.  In addition, ROA helps us compare across retail categories, as it takes into account both margins and productivity.  The top performers were clear leaders in their segments – Home Depot and Tractor Supply (home improvement), Ross Stores and TJX (off-price), Ulta (beauty), AutoZone and O’Reilly (auto parts), Foot Locker (athletic footwear), American Eagle (fashion), Publix (supermarkets), Dollar General (extreme value), Williams-Sonoma (home).      

Overall, we can divide retail performance into four groups - star performers, the weakening middle market, the adapters, and the question marks.  These classifications cut across retail sectors, reflecting the fact that changes in ecommerce and competition are broad based and are no longer concentrated in some product categories.

The Star Performers


The most significant result continues to be the explosive growth of Amazon, but with the development of much stronger financial performance.  Total Amazon revenues grew 31% in 2018 to $233 billion.  Of this, we estimate that $197 billion of this amount represented retail activities.[1] Overall, Amazon accounted for about 48% of US online sales and more than half of total ecommerce growth in the US in 2018. Financial performance strengthened markedly, as net income more than tripled rose from $3 billion in 2017 to $10 billion in 2018. Amazon’s operating cash flow grew from $18.4 billion in 2017 to $30.7 billion in 2018.  With this cash, Amazon invested $13.4 billion, predominantly in fulfillment capacity and in AWS technology infrastructure.  The company also continued to build substantial cash on its balance sheet, adding almost $12 billion to end the year with just over $32 billion.

These results were driven by the evolution of Amazon’s business model. In North America, the extension of Amazon Prime expedited shipping to third party sellers has resulted in rapid growth of Fulfillment by Amazon.  Other retailers can use both Amazon’s platform and logistics to sell online.  These third party sellers are the fastest growing part of Amazon’s business, representing over 40% of the items listed and more than half of the unit and dollar volume.  These third party sellers increasingly sell higher value, lower turnover items, with Amazon collecting commission and fulfillment fees (at estimated profit margins ranging from 6%-40%).  In effect, Amazon is transforming a significant part of its business into an eBay-like model, except that (unlike eBay) Amazon is able to capture commissions from each part of the retail value chain.      

[1] Amazon’s segment reporting is based on geography, rather than activities.  Of the total $232.9 billion in revenues, Amazon Web Services represented $25.6 billion and advertising another $10.1 billion.  Subtracting these from the total gives us the $197.2 billion estimate.  This figure includes $14.2 billion revenues from subscription services such as Amazon Prime and Kindle ebooks.  We include these revenues much as membership fees are included in Costco revenues.

Other Winners

Other retailers turned in strong performance in terms of sales, profits, and returns. Home Depot reached $108 billion in sales, with higher returns. Sherwin-Williams’ results continued to improve. Both TJX and Ross again turned in strong performances.  Dollar General added over $2 billion in revenues, but with slightly lower margins. Ulta Beauty added over $800 million in sales while increasing returns on sales, assets, and equity. Costco was able to add $12.5 billion in sales while maintaining margins.

Retail Challenges: The Hollowing Out of Traditional Middle Market Retail

Traditional retailers who historically served the middle market continued to be under severe pressure.  These challenges were particularly pronounced for promotional (high-low) supermarkets and department stores.  Mainline supermarkets like Kroger, Weis, and Ingles faced EDLP competition from Aldi and Walmart.  The acquisition of Supervalu by United Natural Foods has consolidated food wholesalers, while the associated supermarket banners are being sold off to private equity or closed. The department stores continued to struggle.  Sears finally filed for bankruptcy, having lost another $383 million in 2018, and saw its sales shrink to $16.7 billion.  JCPenney continued to struggle, dropping $500 million in sales and having its net loss more than double to negative $255 million.  Other department stores, including Macy’s and Dillard’s, were only able to maintain revenues with extensive discounting.  In contrast, the EDLP and value retailers continued to take market share in the mid-market.

The “Adapters”

We have described the “adapters” as those companies who are fundamentally revising their business models to the realities of ecommerce competition and to omnichannel retailing.  These changes take a number of forms, from right-sizing store sizes and store networks, to revising merchandise pricing and margins, to adding fulfillment and service capabilities across channels.  This changed environment brings the challenge of lower revenues and margins, and the need for greater productivity to reduce breakeven levels and to build profitable digital operations.  The best example of this adaptation has been Best Buy, which has built a new omnichannel model in an environment of fierce price competition, declining average selling prices, and legacy costs. Best Buy had another good year in 2018, growing sales almost $700 million with increases in margins, productivity, and returns. 

This adaptation brings with it the financial challenge of higher sales only being achieved through lower gross margins, while omnichannel investments are front-end loaded with longer term potential payoffs.  Wal-Mart continued to rationalize its network while reallocating its capital funding toward ecommerce investments and acquisitions (most notably the 2018 acquisition of Flipkart for $16 billion).  These actions have begun to pay off for Walmart, as revenue grew 3% to $514 billion, albeit with lower margins and returns.  After years of restructuring, Target continued to make progress in 2018, with sales growing to $74 billion and return on sales only slight down. 

The Question Marks

In a different category than the adapters were those retailers who not only struggled with declining margins and returns, but were also unable to generate top-line sales increases to help offset the changing retail environment.  This group includes a broad spectrum of formerly leading retailers, including L Brands (Victoria’s Secret), Walgreens Boots Alliance, Lowe’s, Bed, Bath, and Beyond, Advance Auto Parts.  Acquisitions problems continued to weigh on results at Dollar Tree.  Other companies that have been in multiyear turnarounds continued to falter, including RiteAid and Office Depot.   

International Retailers

Table 5 (pdf) reports results for a group of major international retailers.  Only 11 of the 23 retailers experienced increases in Return on Equity.  Some these increases were quite small while others were the result of comparisons to prior year losses, writeoffs, and restructurings. 

Leading performances were turned in by Kering, Woolworths Australia, Inditex, Fast Retailing (Uniqlo), and H&M (although inventory challenges continued to hurt H&M in 2018). For European retailers, the financial and economic problems from the soft economy continued in 2017.  Competitive pressure from hard discounters Aldi and Lidl continued as a major challenge to European food retailers.  The Ahold-Delhaize merger saw flat results. The performance of Tesco, Morrison’s, Metro, and Sainsbury/Asda continued to be soft.  

Wesfarmers (Australia) results were shaped by the demerger of Coles Group food business.  Carrefour’s series of strategic restructurings appears to stumble again, as did Fonciere Euris (Casino).  The largest Japanese retailers continue to post weak results.  Even Seven-Eleven Japan, long-recognized as one the world’s premier convenience store chain, suffered flat sales and returns.      

Best Performers for 2018

Our selections for best performing publicly traded retailers are:

  • Best Upscale Department Store: Nordstrom
  • Best Broadline Department Store: none
  • Best Discount Department Store: Walmart
  • Best Online Retailer: Amazon
  • Best Off-Pricer: TJX, Ross
  • Best Extreme Value: Dollar General
  • Best Specialty Apparel: Inditex (Zara)
  • Best Specialty Hardgoods: Ulta Beauty
  • Best Consumer Electronics: Best Buy
  • Best Convenience Store: 7-11 Japan
  • Best Home Improvement: Home Depot
  • Best Supermarket: Publix
  • Best Pharmacy/Drug: CVS Health
  • Best Home Retailer: Williams-Sonoma
  • Best Office Supply: none
  • Best Specialty Automotive: AutoZone
  • Best Turnaround: Best Buy
  • Biggest Challenges: Sears, JCPenney, Office Depot, RiteAid, Lowe’s

*For the full set of results, download SPM Retail Results FY 2018 (xlsx).