How high can you raise prices before customers balk? Inflation 101 w Prof T Snitz PHD.

Until recently, companies like Proctor and Gamble have used the pandemic as an excuse to raise prices. Yes their material costs were up, but they jacked up prices well behind that. Now the party's over. Buckle up buttercup.

Target, Walmart Earnings Selloff Puts Retailers’ Inflation Pains on Display

Higher costs on fuel, products and wages prompt some companies to rethink how and when to raise prices further

By Suzanne Kapner, John Stensholt and Orla McCaffrey, WSJ

Updated May 18, 2022 5:53 pm ET

Inflation is catching up with some of America’s biggest retailers, as their recent quarterly results were pinched by higher costs on everything from products to fuel.

Investors dumped shares of Walmart Inc., WMT -6.79%▼ Target Corp. TGT -24.93%▼ and other big chains—notching some of the biggest declines since the market crash of 1987—amid fears that the companies wouldn’t be able to pass along higher prices to consumers. It has also stoked concerns through financial markets about the resilience of companies that collectively employ millions of workers in the U.S. and abroad.

The declines were part of a broad wave of selling Wednesday that erased 3.6%, or more than 1,100 points, from the Dow Jones Industrial Average and 4% from the broader S&P 500 index. Major indexes have tumbled this year in response to moves by the Federal Reserve to raise interest rates to fight the highest inflation in decades.

The selloff, which began earlier this year with highflying tech companies such as Nvidia Corp. NVDA -6.82%▼ and Meta Platforms Inc., now has investors wrestling with the idea that the economy could be headed for a recession. Federal Reserve Chairman Jerome Powell said Tuesday that the central bank’s resolve in fighting inflation shouldn’t be questioned, even if it requires pushing up unemployment.

“We’re really in an inflation scare this year, and essentially, the concern is that the Fed is going to aggressively choke out growth as well as inflation,” said Garrett Melson, a portfolio strategist at Natixis Investment Managers.

Target shares tumbled 25% after the retailer posted weaker-than-expected quarterly earnings and said it would rather absorb higher costs than raise prices on shoppers. Target management said fuel and freight costs will be $1 billion higher this year than it had expected, with little sign of their easing this year.

“While we don’t like the impact to our profitability in the short term, we know it is the right thing to do for our guests and our business over the long term,” said Target Chief Financial Officer Michael Fiddelke on an earnings call Wednesday.

Walmart said Tuesday that higher product, supply-chain and employee costs ate into its profit in the latest quarter, a result that Chief Executive Doug McMillon described as disappointing. The country’s largest retailer by revenue said that while it generally passed along price increases from suppliers to consumers, inflation in fuel costs came faster than it expected and that it would continue working to keep prices on groceries low. After Walmart’s stock shed more than 11% after its earnings report, shares retreated an additional 6.8% Wednesday.

Targets plans to absorb higher costs, rather than raise prices on shoppers.

PHOTO: RICHARD B. LEVINE/LEVINE ROBERTS/ZUMA PRESS

Analysts said the weaker results showed that consumers were beginning to curtail spending amid higher prices. “Underlying volumes are looking really soft,” said Neil Saunders, managing director of research firm GlobalData Retail. “This is the beginning of a consumer pullback.”

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Many large companies, including retailers, have been able to increase profits during the Covid-19 pandemic even while facing rising costs for shipping and staffing. Passing along price increases to customers while cutting expenses has been a common path to raising profit margins, but the latest results suggest there might be limits to that strategy amid current economic conditions.

The broader concerns within the retail and consumer-goods sectors weighed on companies including Best Buy Co., BBY -10.51%▼ Macy’s Inc., M -10.66%▼ Dick’s Sporting Goods Inc., DKS -14.22%▼ Dollar General Corp. DG -11.11%▼ and Costco Wholesale Corp. COST -12.45%▼ in Wednesday trading. Shares of those companies dropped more than 10% on Wednesday.

Lowe’s Cos. LOW -5.26%▼ said comparable sales fell 4% in its first quarter, driven lower by cooler weather and reduced spending from consumers completing their own home renovations. Home Depot Inc. HD -5.24%▼ reported a quarterly sales increase of 3.8%, but said fewer shoppers visited the home-improvement chain’s stores.

Both companies slightly increased their profits in the latest period, but said that higher levels of spending per trip helped them manage rising merchandise costs.

Lowe’s and Home Depot benefited from a surge in demand for home-related products during the pandemic. Their sales are softening as shoppers revert to spending on other things, such as travel and dining out, analysts said.

Americans continued to spend briskly in April on products as diverse as cars and clothing, which economists and company executives say is a sign that consumer spending is relatively healthy. But consumers are also showing signs they are less willing to absorb price increases and are trading down to less-expensive items, according to retailers and manufacturers.

Sales at Lowe’s fell as consumers spent less to complete renovations.

PHOTO: DAVID PAUL MORRIS/BLOOMBERG NEWS

One beneficiary of the trade-down effect has been TJX Cos., which sells name-brand products at lower prices than department stores and other full-price chains. But even TJX experienced a hiccup in the first quarter, when most of its sales gains were driven by its international business. In the U.S., same-store sales were flat from a year earlier.

TJX CEO Ernie Herrman said shoppers at the company’s T.J. Maxx, Marshalls and HomeGoods stores aren’t pushing back against price increases, mainly because those prices are still lower than what consumers would find at full-price chains. He said he expects sales to pick up in the second half of the year.

Other retailers, including Kohl’s Corp., KSS -11.02%▼ Macy’s and Gap Inc., GPS -9.84%▼ are scheduled to report earnings later this week and next week, providing a broader picture of consumer health.

Analysts are watching closely for any signs that the chains are starting to discount more aggressively. One possible trigger: Walmart finished the quarter with too much general-merchandise inventory, according to Paul Lejuez, a Citi analyst. He expects Walmart to discount more to clear the goods, which could place pressure on other chains—including Gap and Target—to do the same.

Target and other retailers had benefited from rising sales of higher-margin goods such as kitchen appliances, television sets and furniture during the pandemic, and profits increased. On Wednesday, the company said earnings for the April quarter were hurt by higher markdown rates and inventory impairments, and lower-than-expected sales in those discretionary categories.

“We did not anticipate the rapid shifts we’ve seen over the last 60 days,” Target CEO Brian Cornell said about elevated transportation and freight costs on an earnings call Wednesday.

Mr. Cornell said customers were buying fewer big items—such as bicycles, TVs and kitchen products—than in the past two years. Shoppers are “moving from buying small kitchen appliances and maybe replacing that with gift cards to restaurants and entertainment as they return to a more normalized lifestyle,” he said.

While the Target chief said the spending shift has been significant, shoppers are continuing to visit the retailer’s stores. The number of transactions rose nearly 4% in the April-ended quarter, the company said.