Target, Costco More Popular, Higher Costs Remain a Threat

Prices of imported consumer goods in the U.S. fell for the first time in ten months, according to data released by the Bureau of Labor Statistics. The 0.4 percent drop surprised many analysts, and may spell good news for discount big-box retailers like Target TGT, Wal-Mart WMT and Costco COST, which import a number of non-agricultural goods from external markets. At the same time, a 0.3 percent increase in import costs from China will challenge the big box stores, which have grown to dominate the retail sector thanks to their low prices on imports from Asia. Higher prices for Chinese goods will eat into the companies' margins unless they can look for new markets for low-priced products. This is not news to the retailers, who have seen the cost of Chinese imports rise every month since June 2010, when the goods dropped by 0.2 percent. Analysts have known for a while that higher wages in China will translate into higher consumer costs in America, which partly explains why many companies are finally beginning to repatriate jobs to America. Higher fuel and transportation costs have been another challenge to retailer margins, which the companies have been able to combat with higher revenues. Wal-Mart, for example, saw grocery sales increase by nearly 4 percent in the last quarter of 2011, and Costco beat expectations in its recent earnings result, thanks to strong revenue and higher consumer traffic, up 5.5 percent in Q1 2012. Big box stores have become increasingly popular with consumers partly for their lower prices, so an increase in import costs from China could prove to be a challenge. On the other hand, consumers are also drawn to the large stores for other reasons. Consumer Reports recently reported that consumers have been moving more and more to big box stores because of the quality of their products as well as the convenience of one-stop shopping that drew consumers to the big chains in the first place. Costco was the top choice according to the survey, and not just for product value, although that was a factor. Respondants also cited Costco's strengths in customer service, convenience, and product quality. If Costco is well positioned to benefit from increased consumer traffic in retail chains despite higher prices of Chinese imports, it is not alone. Target, which was also praised in Consumer Reports's survey, may see stronger growth in coming months, since consumers often choose the retailer as a more upscale option to Wal-Mart and Costco. Target exceeded sales forecasts in January with a 5.1% increase in retail sales despite a lower-than-expected rise in U.S. retail sales overall. Target still hasn't benefitted as much as Costco, which saw an 11 percent increase in January as total net sales rose to $7 billion for the four weeks ending January 29th. If the Consumer Reports survey can be trusted, that drive to Costco is not fuelled by frugality, as some analysts have suggested. The shift to retail chains may continue despite higher prices from China, but thinner margins will keep pressuring the companies' bottom lines unless they see more foot traffic in their stores. Lower unemployment may help drive up revenue, but not if consumer confidence continues to fall as gas prices continue to rise. Since most U.S. consumers drive to retail stores, higher prices at the pump could quickly reverse a recent move toward big box stores. While the Consumer Reports survey will give executives at Target and Costco much to cheer about, they should worry that too much pressure on Americans could quickly change the mood.