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A Modest Shift In Retail Spending Amid Variant Uncertainty Doesn't Dim Outlook On Retail And Restaurant Ratings

Advance estimates of monthly retail sales reported by the U.S. Census Bureau increased modestly by 0.7% in August, largely in line with our expectation of near 1%, assuring retailers and restaurants that fears of the delta variant did not cause consumers to dramatically reverse shopping and dining behaviors that have benefited the sector since the economic reopening in spring 2021.

Sector-wide positive momentum has enabled issuers to rapidly repair the damage from the worst of the COVID-19 pandemic and economic shutdown in 2020.   Positive rating actions continued to outnumber negative actions in August and September month-to-date. Remarkable strength in apparel in department stores is consistent with strong recent earnings announcements and upward revisions of guidance this year. The number of consumers flush with cash and eager to shop has translated to full-price sales for these issuers, a dynamic they haven't enjoyed for years. Nearly all of our rating actions in apparel and department stores have been driven by improving performance. We upgraded both Macy's Inc. (BB-/Positive/B) and The Gap Inc. (BB/Positive/--) in early September, and we believe there is upside to the ratings. Even luxury department store NMG Holding Co. Inc. (Neiman Marcus; B-/Positive/--) was able to emerge at long last from the 'CCC' category to 'B-' with a positive outlook.

Spending at food services and drinking places continued to be well above pre-pandemic levels as consumers still want to get out of the house and feel comfortable enough to do so despite the variant.   We recently upgraded several restaurants because of higher sales levels and greater efficiencies, including Bloomin' Brands Inc. ('BB-/Stable') and CEC Entertainment LLC (Chuck E. Cheese; 'B-/Stable'), which reported July sales approaching 2019 levels.

A modest shift across categories suggests consumers realize their time at home will likely remain above pre-pandemic levels while variants pose risk to health and safety.   The delay of many employers' plans to return to office is likely contributing to the modest increase in spending on building materials and furniture as consumers return to home improvement projects. The grocery segment saw another significant increase after a pause in July, illustrating consumers' financial flexibility to stock up at home while and also dining out.

The meaningful uptick in e-commerce demonstrates consumers' comfort shifting between channels.   As we said in August ("Just When U.S. Retailers And Restauranteurs Thought It Was Safe To Reopen, The Delta Variant Emerges," published Aug. 2, 2021), we expect coronavirus resurgences to cause intermittent spikes in e-commerce. Retailers with the resources and scale to achieve margin parity between channels are best positioned to benefit from these dynamic shopping preferences. We raised our rating on Amazon.com Inc. to 'AA/Stable' in June on our view that although some reversion to brick-and-mortar is inevitable as consumers enjoy getting out of the house, we believe the shift toward online is secular and will power Amazon's healthy long-term growth trajectory.

Delta isn't the only risk to retail and restaurants.   Although our base case reflects our view that inflation trends are transitory, we are increasingly attuned to signals that costs could spiral. Freight, logistics, labor, and cost pass-throughs from manufacturers are likely to dampen (but not outright rain on) the parade of positive performance. As long as the consumer is financially healthy, we believe retailers and restaurants will be able to pass on most of these costs. Supply chain constraints underlying some of the inflationary pressures could pose risk to retailers taking full advantage of elevated demand as they approach the critical holiday season. Retailers have accelerated orders for inventory and explored alternative methods such as air freight to offset expected shipping delays. We don't expect inventory challenges to present significant risks to credit quality. In fact, lower inventory levels will support a less promotional environment in the second half and better margins, which could offset lower volumes.

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This report does not constitute a rating action.

Primary Credit Analyst:Sarah E Wyeth, New York + 1 (212) 438 5658;
sarah.wyeth@spglobal.com

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