As the holiday shopping season approaches, are retailers ripe for a rally?

[AUDIO LOGO] We're just over a week away from the start of the all-important holiday shopping season. The big kickoff event, of course, is Black Friday. Now, a year ago, retailers were struggling with supply chain troubles and empty shelves. This year, facing a glut of supply and squeezed margins, not to mention a looming recession. Joining me now to talk all about it, Jacky He, Global Consumer Discretionary Analyst at TD Asset Management. Jacky, welcome to the program. Let's talk about the health of the sector right now. What are we seeing? Yeah, thanks a lot, Greg. It's a busy week. It's a busy day today. So I would say earnings so far has been mixed. On the one hand, you see Walmart, Home Depot, Lowe's, and even TJX, they deliver amazing results, beat expectations. On the other hand, we saw Target today disappointed because of margin. So overall, I'd say retailers have been fine on the top lines because consumers are buying less. But they're paying more because retailers are just passing that inflation through. The bigger challenge on the sector overall continues to be margin pressure. You think about the cost of labor, transportation, commodities, they are still up there. And the same time, consumers are shifting away from wants to needs. And the needs tend to be lower margin. And the other thing, as you mentioned, is inventory. Now it's the biggest problem. Last year no one had-- pretty much no one had enough products on their shelves. But now, they over ordered. And as supply chain quickly eases, they end up with more products than they want, meaning more discounts and lower profitability. Is there any sense that they're starting to work through that inventory glut? Because as you point out, if you're going to sell these things, you're going to get rid of the unwanted inventory. The best way to do it is to slash those prices. But that doesn't do any favors for your margins. It's good for us, right? [LAUGHS] [CHUCKLING] For you and me, yeah. Yes, they are, but slowly. I do want to point out that not all inventory is created equal. So I think it's more important to look at what's inside that inventory. For example, when we look at Target, they overstock. They overstocked the wrong stuff that are fashion exposed, that are seasonal, that are discretionary. So you need space to save those stuff. And you need people to manage it. That's costly. On the other hand, if you look at Home Depot, they also grow inventory quite a lot. But their products are not fashion exposed. We're walk in at Home Depot stores, already like a warehouse, right? And you see those unsold inventory piling up on that shelves. So Home Depot can easily take them down and to resell next year. So the margin risk is much lower there. As you said, it's a big week for retail earnings. And we're getting a bit of a mixed picture, depending on who the retailer is reporting. But then we've got retail sales number as well. And I think they came in a little stronger than expected. What is this telling us about the consumer? Yeah, that's the good news today. We got some help from higher gasoline prices. We got some help from recovering all those supply chain. But even excluding that, retail sales still surprised to the upside. I want to look at the bigger picture. Year-over-year we are looking at about 8%. That's way above that 4% pre-COVID, although they're decelerating. The real question is, how long can that last? I think there's a-- we can have some clue by looking at consumers, how much they have in their pockets, and how much they have in their bank accounts. All the numbers we look at so far, still pointing to good liquidity and good balance sheet. I'm talking about most of them. Some consumers are struggling, but most of them are still fine. So that set up a really good spending power for this upcoming holiday season. I wouldn't be surprised-- people will spend money very differently this time around. You could probably see people spend more on experiences. Earlier in the show, I had a discussion with Hussein Allidina about commodities, about energy, and that the weight that China could have if it started to open its economy more fully past COVID. Could they have an effect on this space as well? They certainly can. China represents about 10% of all the consumer discretionary companies revenue. And they certainly impact inflation through commodity and so on. Last week, they just announced 20 measures to ease that COVID restriction. That's certainly directionally positive for consumption. But I wouldn't hold my breath for a sharp policy pivot because the top leaders just reaffirmed COVID-Zero policy. And at the same time as we speak, China COVID cases has reached a six-month high. When we look at the implementation level, China, you got the central government that sets up that direction. You've got local government that implements. As long as that top priority direction isn't changed, local government tends to have more incentive to over implement that under implement. So that's your risk. And rather to wait for December Politburo meeting, to have a better sense about the direction. I only have about a minute left with you. But I believe you have some names for us to go through in terms of who's navigating, perhaps, this tough time for retail a little bit better than others. It is a tough time. This year, if you look back, a lot of it is about multiples, about valuation. Next year I expect to see more things about earnings. So those who can better protect their earnings and grow their earnings should be better positioned. One name I like is called Tractor Supply. That is the largest operator of retail farm and ranch stores. The biggest driver there, it's interesting, is pet food. During COVID, a lot of us adopted pets. That's not one-time spend. All right. That's subscription. As they grow, you need to feed them. And need to feed them more, regardless it's recession or not. So the other one I like is called TJX. That's a off-price retailer. So we talk about inventory. So when other people have problem with inventory, that's an opportunity for TJX. For Canadians, that's the Winners parent company. So they can now buy those premium brand products at much lower price. And most of that products they are getting today, or through the holiday season, most of them will be sold next year. So their margins should see some meaningful tailwind, there. [AUDIO LOGO]

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