Barclays has downgraded the US retail sector to neutral, citing a combination of intensified promotional activity and weakening consumer demand.
“We believe that promotions are eating into the still-high average unit retails and margins of many companies,” analysts said in a note.
“From this point in the recovery cycle, the only way to drive further margin expansion is leverage from accelerating sales above fixed-cost growth,” they added.
Barclays now believes that the majority of forward outlooks have significantly less upside potential and, in fact, face potential risks to sales and margins in the second half of 2024.
The firm’s downgrade is driven by several factors: the resolution of the inventory glut has led to full margin recapture and peak merchandise margins; the previously favorable conditions in freight, supply chain, and input costs are expected to neutralize in the second half of 2024 and potentially become a headwind in 2025; and compounding inflation is now impacting higher-income households, which disproportionately contribute to discretionary spending.
Moreover, consumer demand for discretionary items has shown signs of softening. Economic pressures, including inflation, have led consumers to be more cautious with their spending.
“With savings depleted and consumer credit availability scaled back, we are seeing consumption reined in across all household income categories,” analysts noted.
"The greatest changes in incremental spending are now appearing in the higher HH income cohorts, where compounding inflation of big-ticket items is now starting to negatively impact marginal spending power at the higher end of the income spectrum, including luxury.”
Despite the slowing consumer backdrop, Barclays analysts still favor companies that stand to benefit from the denim-based silhouette shift, including Gap (GPS), American Eagle Outfitters (NYSE:AEO), and Urban Outfitters (NASDAQ:URBN), as well as those that stand to benefit from a restocking of brands with strong consumer momentum, such as DICK'S Sporting Goods (DKS).
"Each of these retailers has company-specific drivers to return to or accelerate growth in 2H24 despite consumer pressures."