In response to mounting financial strain on households due to escalating interest rates, Bank of America (BofA) announced a significant reduction in profit estimates and price targets for retail giants Nordstrom and Kohl’s on Tuesday. The banking giant warned that the surge in interest rates has led to a surge in delinquencies, potentially paving the way for a surge in charge-offs on department store credit cards in the near future.
BofA analyst Lorraine Hutchinson conveyed in a client note, “We expect KSS and JWN will see a decline in credit revenue in the coming quarters as rising delinquencies turn into charge-offs.”
Historically, store credit cards, some boasting interest rates upwards of 30%, have constituted a major revenue stream for department stores. Experts revealed that credit card sales constituted approximately 87% of operating profits for upscale retailer Nordstrom in 2022, an increase from the 79% reported in 2021. Similarly, Kohl’s saw a substantial portion of its operating profits in 2022 generated through credit card sales, according to industry estimates.
Hutchinson, of BofA, has now assessed the fair value of Nordstrom’s stock at $13, a decrease from the previous valuation of $14. Similarly, Kohl’s stock has been reevaluated at $22 per share, down from the previous estimate of $25.
Moreover, Hutchinson anticipated a “worsening credit cycle” in the quarters ahead, reinforcing the concerning outlook for department store stocks. This pessimistic sentiment, largely driven by apprehensions regarding the credit cycle, took center stage during the second quarter reporting season in August.
During this period, Macy’s (M) reported a sharp 36% decline in second quarter credit card sales from the previous year, plummeting to $150 million. This slump was attributed to the intersection of escalating balances on Macy’s Citibank-powered credit cards and an environment of rising interest rates.
Consumers facing financial constraints, burdened with an exorbitant annual percentage interest rate of nearly 25% on Macy’s cards, found it increasingly challenging to settle their outstanding bills. Consequently, Macy’s opted to write off these balances, a practice that may persist in the coming quarters.
Macy’s CFO Adrian Mitchell explained, “While we have seen an increase in revenues as interest rates have risen, that has been more than offset by higher bad debt assumptions and write-offs.” Mitchell emphasized that these bad debt assumptions and write-offs stem from the escalating delinquencies, leading to amplified net credit losses over time and contributing to a surge in bad debt within the portfolio.
Furthermore, executives at Macy’s noted that households earning $75,000 and under face the most acute financial pressure. Year to date, Macy’s credit card sales have witnessed a staggering 24% decrease compared to the previous year.
Nordstrom echoed Macy’s concerns during its own earnings call. Nordstrom CFO Cathy Smith stated, “We have seen delinquencies rising gradually, and they are now above pre-pandemic levels, which could result in higher credit losses in the second half and into 2024.”
In conclusion, the downward revision of profit estimates and price targets by BofA for Nordstrom and Kohl’s underscores the challenging road ahead for these retail giants as they navigate rising household financial stress amidst surging interest rates. As households grapple with escalating interest rates, the ramifications on department store credit cards are poised to reverberate through the retail sector, leaving both consumers and retailers facing an uncertain economic landscape.
Source: Yahoo Finance