It’s time for retailers to trim payroll, turn the lights down and eliminate supply-chain inefficiencies.
Retailers are getting pummeled by higher selling, general and administrative costs, according to an analysis by WWD of publicly traded mass, off-price and specialty apparel companies. Of the 33 retailers analyzed, 18 posted higher SG&A-to-sales ratios in the most recent quarter over the prior year. By channel, 10 of those companies were specialty retailers such as Abercrombie & Fitch, New York & Company Inc., Urban Outfitters and Pacific Sunwear of California Inc.
Within the 18 retailers that showed higher SG&A to sales costs, nine posted changes of more than 100 basis points, which is a red flag to investors who prefer not to see triple-digit changes. More tolerable increases would be between 10 and 50 basis points.
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SG&A line items include things such as employee payroll and pensions as well as commissions. Other items include utilities, rent and insurance as well as general maintenance costs. Marketing costs are also included in SG&A line items. All of these items differ from “cost of goods sold,” which are the direct, attributable costs related to selling (or making) a product.
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From an investor’s perspective, SG&A-to-sales ratios reveal how effectively a retailer uses its cash. SG&A-to-sales ratios should be declining or stable over time, and should be comparable to their competitors. Wall Street tends to forgive companies that show increases in SG&A — as long as they have a plan to address the impact on profits and reverse the trend. Which is exactly what Target Corp. said it would do last week: Chairman and chief executive officer Brian Cornell disclosed plans to “transform” the retailer, which includes steep layoffs, a focus on digital commerce and a push into the urban market. During a Bank of America/Merrill Lynch investors’ conference in New York after Cornell discussed these plans, John Mulligan, executive vice president and chief financial officer of Target Corp., said funding the mass retailer’s initiative would include taking a hard look at operations and the company’s supply chain. Mulligan said “we think there’s a significant opportunity over the next couple of years to take out $2 billion of expense — 25 percent of that in cost of goods, the rest of it in SG&A.” He said the goal is to “become leaner, more efficient and more agile as an organization” while funding the retailer’s innovation plans.
Increasing efficiencies and cutting payroll is one part of reducing the SG&A-to-sales ratio. Another component is working to bolster sales. The trap for many companies, though, is to find a balance between the two approaches. Lay off too many employees, and sales could suffer. Deploy a weak sales strategy, and the needle isn’t going to budge.
Often, an aggressive initiative pleases the investment community. Take Nordstrom Inc. Although the retailer posted a higher SG&A-to-sales ratio for the most recent quarter, the company was praised by Wall Street for a series of initiatives aimed at strengthening sales over the next several years As a result, the company’s stock reached a new 52-week high, and has continued to trade at the top end of that spectrum since the earnings call last month.
That said, it’s easy for a retailer with billions in sales to cut workers and make investments to improve sales. For smaller companies — particularly specialty retailers — tackling the SG&A line is challenging. Smaller specialty retailers don’t have the same economy of scale that larger players do. From insurance and maintenance costs to leases and marketing costs, smaller firms dole out more money than larger retailers.
Moreover, the specialty retailer is more sensitive to market changes than the big guys. Consumers who frequent specialty stores are rarely loyal, and can abandon one retailer for another at the drop of a hat. And as consumers across the market pull back on spending, the specialty apparel stores are often the first to feel the pain.
Still, the specialty segment is an attractive playing field for investors. Gross margins are more robust — when times are good — and profits can impress. But controlling costs is what Wall Street likes to see.
This may explain why Chico’s FAS Inc. revealed last month the closure of 120 stores and a force reduction of 240 employees — mostly at the company’s corporate headquarters. Word on the Street was that Sycamore Partners was eyeing the retailer. So it makes sense that the company would make itself attractive by cutting expenses. The store closures and layoffs will be on top of a 110 basis-point improvement in Chico’s SG&A-to-sales ratio for the fourth quarter.
