Setting the backdrop, Fitch noted that in 2005 shoppers were willing to splurge even as they looked for bargains, prompting luxury chains and warehouse clubs to lead the industry for another year. However, retailers catering to low- and middle-income consumers found difficulty in generating meaningful comp-store sales growth.
During the year, the retail industry also saw an influx of investment dollars, which led to a resurgence of mergers and acquisitions. Notable mergers changed the face of the department store sector during 2005, including Sears/Kmart and Federated/May, while several retailers were taken private.
The ratings company is expecting real estate trading to accelerate next year as a result of these mergers, with retailers rationalizing their store portfolios and underperforming retailers shedding locations. During the call discussing the company's study, Fitch CFA Karen Ghaffari was asked if the company believes mergers and acquisitions that are motivated by real estate assets will decline. She responded that no, retailers would remain interested in acquiring real estate.
"There should continue to be an appetite for the right assets," Ghaffari said. "In any case, real estate in the right locations and of the right size will move, but undesirable won't. The real estate put up for sale that is not very saleable may see some fallback."
Thus far, Federated, Mervyns, and Winn-Dixie have announced that they will be selling certain locations, and Toys "R" Us is expected to begin selling stores and converting others to its Babies "R" Us format. Other potential sellers of real estate include Sears Holdings, Albertson's, and ShopKo. Potential acquirers of mall anchor sites include Target, J.C. Penney, Nordstrom, and Kohl's, while off-mall sites will garner attention from Wal-Mart, Target, Home Depot, and Lowe's.
As discount big-box retailers expand popular offerings, such as electronics and foods, Fitch says it will result in continued pressure on gross margins. When factoring in higher labor, healthcare, and energy expenses, retailers will face even more pressure in a softer sales market. Fitch suggests retailers offset pressures by sourcing more product from the Far East and other emerging markets.
While most subsectors are expected to do well, some will face challenges in 2006. The report predicts that luxury department store chains will continue to outperform the rest of the industry, despite comparable store sales growth slowing from the current high single digit pace.
For supermarkets, 2006 will be an important year given potential merger and acquisition and real estate activity. Strategies including improved customer experience and product offerings, as well as remaining price competitive will allow supermarket operators to differentiate themselves from the non-traditional food retailers. Large-chain drug stores, with continued effort to distinguish themselves from competitors through convenience, strategic positioning, high customer service levels, and unique product offerings, are expected to capitalize on the overall growth of pharmaceutical sales.
The home-improvement chains, such as Home Depot and Lowe's, should continue to perform well in 2006. However, the report notes that these stores could begin to feel the impact of higher interest rates and a softer housing market as the year progresses. Specialty apparel retailers are expected to show mixed results, while toy retailers face the steepest challenges. With greater competition from discounters expanding their toy inventory, smaller toy retailers are up against a difficult year.
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