Walmart, Target earnings set to set retail trends

Reuters- Walmart Inc and Target Corp kick off retail earnings this week, and what the two biggest U.S retailers say about consumers will likely set the theme for the rest of the sector and give clues about the health of the U.S. economy.

A decline in gasoline prices in recent weeks has helped relieve pressure on lower-income shoppers, but inflation is still at a four-decade high. That could lead to the U.S. Federal Reserve on its rate-hike path, potentially tipping the economy into a recession.

Both Walmart and Target saw big inventory builds in the first quarter, and warned of a fall in earnings this year as consumers increasingly shopped for lower-margin goods such as food and fuel.

Bill Smead, chief investment officer of Smead Capital Management, said Target made it pretty clear that the next couple of quarters were going to be hard as they got rid of inventory at lower prices.

Smead said that it could be a buying opportunity for his fund, as the stock could easily retest this year's lows.

Since the major retailers last reported quarterly results, prices shoppers pay for a variety of goods and services have shown signs of cooling after a relentless rise. The consumer price index rose 8.5% in July, but at a slower pace than the previous month, due to a 17% drop in gasoline prices.

The sector is preparing for the back-to-school and holiday seasons, when they earn a big chunk of their annual profits.

Walmart said last month that its second-quarter profit and margins were expected to fall as it slashed prices to clear a $60 billion inventory buildup, a warning that spooked global markets.

Analysts believe that the nation's largest retailer is going to suffer a 6.3% decline when it reports second-quarter earnings on Tuesday.

The Bentonville, Arkansas company's profit margins are likely to be under pressure for the rest of the year because it caters to budget-conscious shoppers who are more acutely impacted by inflation, analysts said.

The low-end customer has not been doing well and hurts Walmart more. Dave Harden, chief investment officer at Summit Global Investments, said Target will not be affected because it caters to a middle-to-higher end customer.

Harden owns more than $50 million of shares in Walmart and Target.

The report on Wednesday is expected to report an over 78% drop in earnings.

J.P. Morgan and Jane Hali Associates think Target will fare better than its bigger rival, as they believe it has done a job of clearing inventory.

Target's stock is looking good, except for a handful of categories where stocks are still inflated, said Jessica Ramirez, an analyst at Jane Hali Associates. J.P. Morgan said the retailer will exit the second quarter with clean inventories, having taken its medicine with price cuts.

Kohl's Corp, Kohl's Corp, and home improvement chains Home Depot Inc and Lowe's Cos Inc are set to report earnings this week, and will likely point out which parts of the retail sector are holding up best against inflation.

The extent to which retailers can clear these lowered bars and signal to investors that they can preserve margins in the back half will determine whether the stock reaction will be positive or negative, said Chelsea Wiater, portfolio manager at EFG Asset Management.