These retailers are most at risk for a margin squeeze this earnings season thanks to cautious consumers, heavy promotions

Affordability is the number one concern for consumers globally, new data released Tuesday by EY shows.

The price worries could suggest trouble for retailers that are relying on promotions to win over cost-conscious customers. Those companies could see their margins under pressure when they report earnings over the coming weeks. 

In a consumer sentiment survey of 21,000 shoppers across 27 countries, 35% of respondents said “affordability” is now their leading concern when it comes to choosing what to buy, according to EY’s Future Consumer Index. The survey’s respondents cited the answer more than any other concern.

That’s up 10 percentage points since Oct. 2022, the numbers show. 

“That’s having knock off effects in terms of what people are shopping for, where they’re making substitutions from national brands to private labels, how they’re thinking about scaling back on things that are not essential to them,” Kristina Rogers, EY Global Consumer Leader, told CNBC in an interview. “And similarly around loyalty. They’re more than willing to go somewhere else if there’s better value elsewhere, if they can do something to reduce costs in their budget.” 

Retailers are likely to lean on promotions to keep struggling customers buying and are “already trying” to do so, even with the hit they are taking to profits, Rogers said. Compounding the issue is growing research showing a shift in consumption habits, she said.

In the past when consumers were buying something on sale, they tended to spend the same amount they would have if they bought the item at full price by adding a few extra items to the cart. But these days, some are buying less, Rogers explained.

“The whole idea is for me to buy more,” said Rogers. “That doesn’t mean I’m going to buy more. It just might mean I come to you and not your competitor… So, you know, I don’t know that helps in the way it might have in the past,” she continued.

The findings come as major retailers, such as Home Depot, Walmart and Target, are releasing earnings this week.

The earnings will offer a glimpse into consumer health and how heavily companies have been relying on promotions to keep shoppers limping to the checkout line in the face of persistent inflation and rising debt at sky-high interest rates.

Retailers that largely sell apparel, shoes or home goods are most likely to see squeezed margins due to promotions this earnings season, according to analysts and research.

“I think we’ll still hear some hurt from Target. I think Macy’s you might hear some of that come through,” said Jessica Ramirez, a senior analyst at Jane Hali and Associates. “Vans is still coming through some promotions that are likely to hurt them. Victoria’s Secret as well. They’ve been very promotional. And then the hardlines, William Sonoma.”

Home Depot on Tuesday missed quarterly revenue expectations and cut its full fiscal year guidance for comparable sales and operating margin rate — though it is unclear whether promotions factored into that forecast.

In a Thursday research note, UBS analysts reported softline promotions increased to 17% in April, a 2 percentage point jump year-over-year. They based it on a statistic they call the “discount factor,” which measures the percentage of goods on sale and the average discount off the original price. Softline retailers are those that sell “soft” goods such as apparel.

The uptick was driven by increases in both the number and size of discounts, and was accelerated by a month-over-month 0.7 percentage point increase, the note said.

“Our view is the market underestimates the pressure on industry sales from US consumers’ decreasing ability and willingness to spend on apparel and footwear. We expect sales trends to weaken over the course of 2023,” the note stated. “This is likely a bad sign for Softline retailers’ 1Q23 gross margins.” 

The bank listed the companies that saw the biggest year-over-year changes in discounts. The public retailers where promotions rose the most are Skechers, American Eagle, Ralph Lauren, The Children’s Place, Under Armour, Nike, Urban Outfitters, Victoria’s Secret, Macy’s and three of Gap’s brands – Banana Republic, Athleta and Old Navy. 

Retailers and brands that have the largest decreases in discounts year-over-year include Gap’s namesake banner, Lululemon, Nordstrom, Foot Locker and its brand Champs Sports.

Since mid-2022, softline retailers have been passing inflationary costs onto consumers, but it suspects companies will give up these price gains in a bid to protect market share “as the macro outlook weakens,” UBS said.

Compared to last year, retailers have some supply chain tailwinds such as reduced freight expenses that are expected to boost margins. But considering the increased promotional environment, it’s not clear if those savings will materialize, said Simeon Siegel, a retail analyst for BMO Capital Markets. 

“Retailers actually have margin relief this year because last year supply chains were so expensive, but that will be offset by promotion,” Siegel told CNBC. “The question is, is it partially offset? Or does it more than engulf the savings?”

He pointed to Gap, and how promotions and higher commodity prices shaved five percentage points off of its gross margins in fiscal 2022, even with lower air freight expenses. 

Siegel expects other apparel mall retailers like Gap are most at risk for promotion-induced margin squeezes this earnings season. 

Last week, Under Armour missed fiscal fourth-quarter expectations on gross margins because it used steep discounts and promotions to drive higher sales, the retailer’s Chief Financial Officer David Bergman told analysts. The company warned the issue could persist.

The analyst Ramirez said the savvier retailers have been selective in the items they choose to promote. They’ve focused on marking down merchandise that’s fallen out of demand, such as home goods, while keeping more coveted items off the discount shelf.  

“It’s leaning into your consumer and their priorities,” said Ramirez. “Retailers today are much more in tune with the consumer interest and the consumer needs than they were before the pandemic.” 

Despite repeated concerns over a more cautious consumer that’s echoed on earnings calls and research desks for the last few quarters, Ramirez pointed out those losses haven’t shown up on retailers’ balance sheets too broadly.

At least not yet.