This Is the Real Threat to Retailers This Earnings Season

Walmart will be the earnings highlight this week. (Photo by JC MILHET/Hans Lucas/AFP via Getty Images)

Wall Street is betting there isn’t much to fear in big-box retailers’ second-quarter results, which should reflect resilient consumer spending. The real risk lies in the companies’ forecasts about the rest of the year, and whether they could herald a broader pullback.

Home Depot kicks off the week of earnings, releasing results on Tuesday, followed by Lowe’s, Target, and TJX Cos. on Wednesday. Walmart and Ross Stores announce earnings on Thursday.

Economic data and results from retailers who reported early in the season suggest that consumer spending was fairly robust throughout the early summer months. June and July’s retail sales were strong, while retailers such as Amazon.com, eBay, Shopify, On Holding, and Ralph Lauren all said they had yet to see a pullback in spending.

Consumers continue to shop confidently as the unemployment rate remains low. That bodes well for many retailers’ sales growth in the second quarter.

“Retailers are broadly positioned to surpass Street 2Q sales expectations,” writes Alex Straton, an analyst at Morgan Stanley who covers apparel retailers.

Better revenue growth means earnings could also come in above expectations for many retailers, she added, even though some companies have warned that tariffs are starting to take a toll on profitability. I/B/E/S data, LSEG’s poll of institutional investors, projects that earnings will grow at an average annual rate of 5.7% in the second quarter for companies in LSEG’s retail and restaurant index. Broadline retailers—companies such as Walmart and Costco Wholesale —are headed for the highest second-quarter earnings growth rate out of all the retail subsectors, with a roughly 31% surge over last year.

Despite what will likely be a solid second quarter, Straton and other analysts are wary about the future.

“The consumer is continuing to spend,” writes Michael Baker, an analyst at D.A. Davidson, in a research note. “But signs of weaker labor growth adds to concerns that that trend may slow in the back half. This makes for a cautious set up heading into the heavy part of retail earnings.”

Indeed, a July TD Cowen survey of consumers found that 51% of respondents were planning to cut spending in the coming months as a result of weakening economic conditions. Discretionary spending is first on the chopping block: People were planning to spend less on dining out and social events, clothing and accessories, travel, and luxury items. Respondents are also keeping a close eye on price increases, with many saying that a 5% to 10% price increase would prompt them to pull back on spending.

So far, companies and suppliers have opted to absorb many tariff-related costs to avoid passing them on to consumers. As more levies come into effect, it’s unlikely they will continue to do so. Some companies that have already reported have flagged that tariffs are taking a bite out of the bottom line.

“In the coming months, we expect retailers to pass on more price increases as tariffs drive costs up, which could have a bigger
impact on demand elasticity in H2,” writes Zhihan Ma, an analyst at Bernstein. Consumers will be quick to catch on, especially as retailers bring out tariff-sensitive seasonal items, such as back-to-school supplies or holiday décor.

Ma expects retailers will talk more about their pricing strategies this earnings season, and investors will want to know more about tariff-mitigation strategies.

How companies deal with the uncertainty may very well be the difference between the sector’s winners and losers. Ma says discounters such as Walmart, Costco, and Dollar Genera l are well-positioned heading into this earnings season and the second half of the year. They benefit from their ability to meet consumer demand for bargains.

Home improvement companies, such as Home Depot and Lowe’s, may continue to struggle, reflecting the weakness of the housing market. Specialty retailers and department stores may also find themselves in a tough spot as discretionary spending takes a back seat to essentials. Straton, the Morgan Stanley analyst, is expecting “widespread” cuts to full-year earnings per share guidance across her area of coverage.

Don’t be too surprised if many companies’ earnings reports end up looking a lot like Tapestry’s. The parent company of Coach and Kate Spade topped second-quarter earnings and sales expectations, and issued full-year revenue guidance that was ahead of Wall Street’s projections. Yet the company’s earnings projection for the year fell short of expectations, due in part to tariff-induced pressure on profit margins. On the day Tapestry reported, its shares were the S&P 500’s worst performer.

For that reason, Straton advises investors to maintain a cautious stance for the second half, even if the second quarter itself looks solid.

Write to Sabrina Escobar at sabrina.escobar@barrons.com