Inflation: ‘We’re seeing a lot of pressure’ on retailers’ operating margins, analyst says

Mickey Chadha, vice president at Moody's Investors Service, joins Yahoo Finance Live to discuss how the retail sector has been batted by inflation and what that means for consumers as a result.

Video transcript

RACHELLE AKUFFO: If you've been watching what's been happening with Walmart and Target, you want to watch this. We're taking a look at what's been happening with retailers. For that, let's bring in Mickey Chadha, Moody's investor services vice president. Mickey, thank you for joining us today. So as we've seen, Moody's lowered its outlook for the US retail and apparel industry to negative on May 16. Talk about what you're watching in terms of the business conditions and the risks.

MICKEY CHADHA: Well, thanks for having me. So as you know, retail last year, up till last year, it was doing phenomenally well. The consumer was still strong. It was resilient. Retail sales are still looking positive. The reason we went negative is, we're seeing a lot of pressure on the operating margins of retailers. As you saw from the reports of Walmart and Target the last couple of days, the consumer is feeling the pain of higher prices of food and energy. And gas prices are record high. Food prices are up. And so disposable income is shrinking.

And so the consumer is pushing back into what they're buying. So you've got these different events happening at the same time, where retailers were taken by surprise and had inventory that they had bought to sell, looking at the robust consumer. And then things turn pretty quickly as inflationary pressures started to creep up and cost pressures. Retailers are feeling cost pressures on labor costs, their wages, input costs. And so their operating profits are definitely feeling the pressure. And so we went negative. And we're expecting the operating profits to decline for retail by 1% to 3% this year. And so, a lot of the retailers are going to feel this in the next coming quarters.

RACHELLE AKUFFO: And it's interesting because when you look at Walmart, obviously, it's considered that bellwether of how US consumers are feeling. Earnings disappointed. We saw that Target's were even worse. But then you have Kohl's, which seems to be faring better. What's making some retailers more resilient than others right now?

MICKEY CHADHA: Well, if you look at Kohl's, Kohl's is a department store. And it is about-- I look at it as being a value priced department store, a lot of private label product. It's off mall. And there is another trend that is happening with consumers, is that because of all the pandemic restrictions being removed, the trend from goods to services is also increasing. And that means that people are traveling more, and they're replenishing some of their wardrobe as well, as they get together with family, as they travel, and as they socialize more.

And so we're seeing that play out as well. And so certain retailers are probably going to weather the storm better than others. But Walmart and Target are very large retailers. And they have the capacity to withstand this pressure in the coming quarters. They're very good in inventory management. And they'll rightsize their inventory based on consumer demand. So in the longer run, I think those retailers are stronger, they're bigger. They have the scale. They have a merchandise mix that resonates with the consumer.

And Walmart, don't forget, is the largest food retailer in the country. And so-- and that is an essential item that consumers need to buy. And so it's not-- it's a non-discretionary item. And that drives traffic into a Walmart store. And we've seen Walmart take share in food as its prices are better than the competition. And so that is a benefit that Walmart has.

RACHELLE AKUFFO: And as you mentioned there, some brighter days ahead, as you mentioned, for some of these stalwarts, your Walmarts and your Targets. But you also identified four sectors that still have momentum left in the months ahead, but for different reasons-- auto and auto parts, home improvement, value stores, and off price. What are you watching in those spaces?

MICKEY CHADHA: So when you look at auto and auto parts, autos have had record profits. And that's primarily because there's a shortage of cars. And so they have been pricing the cars at a higher price where the consumer has the choice that they want a car. There's a shortage of chips in that industry. And so the pricing and the profit per car that these retailers are generating is a lot higher than it has been. And so, we think that that's going to continue, although at a lower pace.

When we're looking at off price, for example, that is a trade down for consumers. And off price has always been very good in managing their inventory. If you go to a TJX or a Burlington, if you're in the store and you like something and you don't buy it then, there is no guarantee that the product would be there when you get back tomorrow or next week. So it's more of a treasure hunt kind of a purchase that resonates with consumers that go in and they pick up something that is priced lower than the competition. And it might not be there. So those kinds of retailers are going to fare well.

RACHELLE AKUFFO: Well, we will have to leave it there, unfortunately. I know we'll definitely have to have you back to break more of that down. Mickey Chadha there, Moody's Investors Service vice president.