By Michael Wursthorn 

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (May 14, 2019).

Shares of retailers, buffeted by rising trade tensions in recent sessions, face a key test this week when Macy's Inc., Walmart Inc. and others begin reporting quarterly earnings.

The S&P 500 Retailing index fell another 3.2% Monday, extending last week's 3% slide after President Trump pushed ahead with tariff increases on billions of dollars of Chinese imports. That outpaced the broader S&P 500's 2.4% decline Monday, as shares of Macy's, J.C. Penney Co., Best Buy Co. and Ralph Lauren Corp. all fell more than 3%.

The slides could worsen later this week once retailers begin reporting earnings, analysts said. Investors will want details on how merchants plan to absorb 25% tariffs on more than $40 billion of goods that are imported from China and directly purchased by U.S. consumers. Macy's and Walmart are among the first to release results, with reports due Wednesday and Thursday, respectively.

The tariffs, which took effect Friday, hit clothing, luggage, handbags and furniture, among other consumer products. And retailers have few options: They can absorb the added costs themselves, spread them across their vendors or pass them on to customers.

None of those options is particularly attractive, analysts said, and retailers' pain could signal broader implications for the U.S. economy. Initial estimates project the additional tariffs will shave 0.3% from U.S. growth this year.

"When this tariff conversation started last year, retailers were in a stronger position," said Simeon Siegel, a senior retail analyst at Instinet. At the time, economic conditions were better and retailers were cutting back on inventories. "But now, things have normalized, inventories are up again and retailers can't really raise prices," Mr. Siegel said.

Profit margins are already under pressure, as companies such as Walmart and Target Corp. have been spending heavily on upgrading their digital capabilities and remodeling their stores. Absorbing higher tariff-related costs would further stifle margin expansion, analysts said.

In the previous earnings-reporting season, both companies reported slimmer profit margins, but results were upbeat overall, helping to send their shares higher. Walmart's stock remains up 7.2% this year, while shares of Target have added 8.5%.

Consumer-discretionary stocks, excluding internet retailers, are expected to log a 5.2% contraction in first-quarter profit margins from a year earlier, according to data compiled by Credit Suisse. Margins among consumer-staples companies, which include Walmart, are expected to shrink 5.8%.

That could lead retailers to raise prices in an effort to protect their margins, analysts said, but companies run the risk of stifling revenue if customers pull back on spending. Consumers' pockets appear relatively healthy thanks to a tight labor market and rising wages. But retail spending has been mixed in recent months following a weak holiday sales season, a sluggish February and a rebound in March, according to Commerce Department data.

With a 25% tariff on apparel items, retailers would have to raise prices by 2.3% to maintain their gross margins, according to analysts at Bank of America. If they can't raise prices, analysts say the tariffs could compress retail earnings by 39% this year.

Some companies have been trying to insulate themselves from the U.S. and China trade spat, which could soften the blow of tariffs, analysts said. Several companies have been shifting production from China to other Southeast Asian countries in recent years. Others had been rushing goods over from China, ahead of the tariffs, Credit Suisse's retail analysts wrote in a note recently.

Even if the fallout isn't as bad as expected, the market has reacted harshly to the idea of tariffs. Last year's volatility was spurred, in part, by President Trump's protectionist policies. And the S&P 500's 2.2% slide last week -- its biggest weekly loss of the year -- came after President Trump's initial threat to raise the levies on Chinese imports.

The S&P 500 took another leg down Monday after China retaliated Monday by raising tariffs on about $60 billion of U.S. goods, falling 2.4% for its biggest daily decline since Jan. 3. As long as tariffs remain in place, investors' doubts alone could be enough to drag retail-stock prices even lower.

"The fear of global trade...deteriorating amid macro fears during previous U.S./China escalations" had the biggest impact on stocks over the past six months, Credit Suisse analysts said, even though costs didn't drastically increase.

Write to Michael Wursthorn at Michael.Wursthorn@wsj.com

 

(END) Dow Jones Newswires

May 14, 2019 02:47 ET (06:47 GMT)

Copyright (c) 2019 Dow Jones & Company, Inc.
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