In Retail: One Segment’s Loss is Another Segment’s Gain

In the OECD regions, the increasing pressure on consumers—characterized by tighter credit conditions, resiliently high energy prices, and inflationary pressure on food prices, along with a slight rebound in unemployment and plummeting housing activity in the United States—has progressively eroded consumers' confidence. Consequently, consumers started to adjust their demand at the beginning of 2008, and are expected to continue doing so in the months to come.

This will undoubtedly take its toll on the retail sector. But one industry's loss is another industry’s gain; and while the home improvement segment is expected to be hit hard, big retailers in the food and drink industry should be somewhat insulated and could even benefit from a shift in consumer spending from discretionary goods towards their segment.

A significant threat stems from a risk of overheating in China, where an investment boom is creating an excess capacity and accentuating credit risks in the state banking sector. A Chinese hard landing, along with a severe downturn in North America, would be a massive blow for the retail sector globally. Indeed, together North America and China accounted for about 40% of the total sales in the sector in 2007.

On the other hand, profitability should resist well, as retailers are expected to reorganize their supply chain, clear their inventories, reduce costs, and delay scheduled new capital expenditures until 2009. This should enable U.S. retailers to maintain their operating profit margins, since we only expect them to decrease 0.9% in 2008. Margins will continue to increase sharply in China and India, however, in line with their sales.

On the supply side, the strong opportunity those countries represent for retailers, while the demand in the OECD is forecasted to wane, will encourage further consolidation and internationalization of the retail sector.

We do not foresee any major shakeup among the key leaders, such as Wal-Mart and Carrefour, which, on the contrary, are expected to further consolidate their positions in both well-established and bullish markets, benefiting from a disproportionate loss of shares from smaller players.