Consumer confidence in the US eased in June as shoppers stateside fretted over the economic outlook, with The Conference Board’s consumer confidence index dipping to 100.4 from a downwardly revised 101.3 in May.

This downbeat reading (25 June) came hot on the heels of news retail sales (18 June) across the pond barely rose in May, creeping 0.1% higher month-on-month to $703.1 billion.

That was below the 0.2% increase the market was looking for and confirmed that the American consumer, and the low-income shopper in particular, is finally buckling under the strain of sticky inflation and high interest rates.

WHY THE US CONSUMER MATTERS

This spending fatigue is worrying given the importance of the US consumer to the world’s biggest economy and its ability to move markets. The American consumer has proved surprisingly resilient in recent years, powering GDP (gross domestic spending) higher in the world’s biggest economy with the staying power of its spending confounding predictions that households would be squeezed by inflation.

But with inflation proving sticky, Covid stimulus cheques spent and pandemic savings run down, an array of household name companies ranging from burgers-and-shakes seller McDonald’s (MCD:NYSE) to extreme discounter Five Below (FIVE:NASDAQ) have warned customers are now closing their wallets.

Price hikes from global restaurant chains have tested the loyalty of customers and recently, coffeehouse colossus Starbucks (SBUX:NASDAQ) joined McDonald’s and other chains in pushing promotional deals to win back inflation-weary customers.

WHAT ARE RETAILERS SAYING?

While this long-anticipated consumer spending slowdown raises the likelihood the Federal Reserve will cut interest rates, it suggests the near-term outlook for US retailers is anything but rosy. Retailers are cutting prices in order to hang on to cost-conscious shoppers, which is impacting their margins, and if this subdued consumer demand persists, it will depress sales and could leave them with bloated inventories.

US consumer bellwether Walmart’s (WMT:NYSE) first-quarter figures (16 May) beat on both the top and bottom lines, underscoring the resilience of the Arkanas-based retail giant, which looks better placed than most to weather the storm. Of great significance was the fact the discounter called out market share gains with high-income shoppers who are now flocking to Walmart for its convenience and everyday low prices. In contrast Brian Cornell, CEO of discounter Target (TGT:NYSE) recently bemoaned ‘continued soft trends in discretionary categories’ as low-income shoppers, who are disproportionately impacted by inflation, hunker down and prioritise spending on essentials such as groceries.

WALMART HAS MANY WAYS TO WIN

Walmart (WMT:NYSE) $68.07

Market cap: $547.5 billion

Investors seeking a market share momentum stock should stump up for Walmart (WMT:NYSE), whose forward price-to-earnings ratio approaching 30 times discounts the strong sales gains anticipated in the years ahead. The world’s largest retailer’s value offering resonates with price-conscious shoppers, while upper income consumers are also trading down to Walmart, warming to its competitively priced groceries and the convenience of the one-stop shopping the $547.5 billion cap offers. Walmart beat top and bottom line estimates with its first quarter results (16 May), which showed 3.8% same-store sales growth and 22% e-commerce growth in the US business. Chief financial officer John Rainey called out ‘higher engagement across income cohorts with upper-income households continuing to account for the majority of the share gains’, although with inflation proving sticky, customers are prioritising spending on essential groceries over discretionary general merchandise.

Walmart’s smaller competitor Kroger’s (KR:NYSE) forecast-beating first quarter earnings (20 June) were supported by robust demand for the Cincinnati-based retailer’s cut-price groceries as cash-strapped consumers grappled with sticky inflation. Kroger CEO Rodney McMullen stressed his charge is ‘delivering exceptional value at a time when many customers need it more than ever, by providing affordable prices with personalized promotions’.

Discounters should be mopping up market share in this environment as inflation-weary shoppers trade down in their quest for value, but high inflation, elevated interest rates and high prices at the pumps are taking their toll on a low-end consumer who is pulling back in the face of higher costs.

This trend was starkly illustrated by a disappointing first-quarter update (5 June) from value stores operator Five Below (FIVE:NASDAQ), whose comparable sales were down 2.3% year-on-year for the quarter ended 4 May 2024. CEO Joel Anderson explained that Five Below saw ‘positive comparable sales from our higher income customers; however, the macro environment disproportionately impacted our core lower income customers, resulting in overall comparable sales declines.’

The squeeze on spending is also revealing itself in other sub-sectors of retail. On 27 June, Walgreens Boots Alliance (WBA:NASDAQ) CEO Tim Wentworth said his charge continues to face ‘a difficult operating environment, including persistent pressures on the US consumer and the impact of recent marketplace dynamics which have eroded pharmacy margins’, while consumers are even cutting back on athletic apparel and must-have sneakers, with fourth quarter revenues in North America, Nike’s (NKE:NYSE) biggest market, coming in shy of market expectations at $5.28 billion.

The sportswear giant’s slowing growth and warning (27 June) on the outlook for the current financial year reinforced investors’ concerns about the sneaker giant, whose shares are down 30% year-to-date. Meanwhile, shares in joggers-to-tank tops seller Lululemon (LULU:NASDAQ) have slid 40% lower year-to-date reflecting worries that demand for its pricey leggings is plateauing across the pond.

WHAT THE RESTAURANTS ARE SAYING

Investors looking for signs that the US consumer is buckling after two years of high inflation need look no further than fast food giant McDonald’s, which missed first quarter earnings (30 April) for the first time in two years.

CEO Chris Kempczinski described consumers as ‘even more discriminating’ as they faced elevated prices in day-to-day spending, forcing them to cut back on going out for dinner.

Finance chief Ian Borden reinforced the idea that everybody is fighting for fewer customers who are visiting the stores less frequently. McDonald’s same store sales in the US were flat in the quarter, while the company’s international markets were even weaker.

In response the company is pulling out all the stops by reintroducing its value meal to lure penny-pinched customers back to the Golden Arches. President of the US business Joe Erlinger told Bloomberg, ‘We are committed to winning the value war’. The new $5 meal deal consists of a cheeseburger, small fries, four-piece chicken nuggets, and a small soft drink.

THE FUND MANAGER’S VIEW

Jon Brachle, one of three managers on investment trust JPMorgan US Smaller Companies (JUSC), tells Shares: ‘When it comes to US consumer spending, we’ve observed that high-income individuals have remained more resilient, while those in low to middle-income wage brackets have cut back, especially on discretionary items. For instance, burger chains in the US have reported a drop in consumption from customers earning less than $75,000 a year. Generally, we’ve seen that more expensive non-essential spending, like leisure goods and cosmetic dental procedures, have decreased, particularly among those who need credit or financing to support such purchases.’

However, Brachle sees some positive signs. ‘Despite the slowdown, job growth has been solid, and real wages have increased over the past year. Looking ahead, we expect spending among low to middle-income consumers to remain under pressure in the short-term, while high-income spending may also soften slightly.’

News of the promotion provoked an immediate response from competitors with arch rival Burger King, part of the Restaurant Brands International (QSR:NYSE) group, pledging to roll out its own $5 meal deal before McDonald’s.

Wendy’s (WEN:NASDAQ) has launched a $3 breakfast as the firm took to social media to mock competitors’ ‘copycat’ ideas. Even relatively pricey Starbucks (SBUX;NASDAQ) couldn’t resist getting in on the action and launched its own $6 combo coffee and sandwich deal.

McDonald’s argues its sheer scale means the incremental cost of adding fries and a drink is minimal. Not all franchisees agree, with one independent group telling its members there isn’t enough profit in the meal deal to make it sustainable. Franchisees operate around 95% of US stores.

The meal deal initiative is as much about re-establishing McDonald’s hard-earned reputation for affordability as it is about luring back consumers. Its reputation has taken a hit in the last couple of years as franchisees hiked prices by an average of 40% to offset higher costs.

Consumers have taken to social media to express concern over the high cost of fast food. Images of a $18 Big Mac combo meal in Connecticut went viral amid claims the cost of a burger has doubled in recent times.

Erlinger insists the example is an anomaly found at just one of its more than 13,700 nationwide locations. Although he concedes the brand has lost some of its relative superiority on affordability. That McDonald’s has an image problem on price affordability speaks volumes about the state of the US consumer.

Rival burger joint Burger King is undergoing a multi-year turnaround and remodelling of its US estate which saw three major Burger King operators filing for bankruptcy in 2023 and several underperforming locations closed.

The company has invested $400 million on marketing to revive the brand in a campaign called ‘Reclaim the Flame’ and is in the process of buying out Carrols Restaurant Group which runs around one in seven of the chain’s 6,800 US sites.

The plan appears to be having the desired effect with the company reporting 4.6% first quarter same store sales growth, ahead of Wall Street expectations as the revival in demand was accompanied by strength as its Tim Hortons coffee outlets.

Pizza franchiser Domino’s Pizza (DPZ:NYSE) also topped analyst estimates for same store sales which increased 5.6% in the quarter. The company is reaping the rewards from changes it made to its loyalty programme which now enables members to earn points from lower-priced orders and redeem them earlier.

CEO Russell Weiner says: ‘Reducing the purchase from $10 to $5, well, all of a sudden, it’s a more compelling program for carryout customers and just customers who don’t want to spend a lot of money’.

The chain has started selling pizzas through Uber Eats with 1.4% of sales coming though that third party channel. Another casualty of low-income consumers cutting back is Yum Brands (YUM:NYSE) which operates the KFC, Pizza Hut and Taco Bell brands. Same store sales declined 2% at KFC while Pizza Hut saw a 7% decline in first-quarter sales.

MARKET GOES CAVA CRAZY 

A new name to emerge in the casual dining space is Mediterranean restaurant chain Cava (CAVA:NYSE) which listed on the New York Stock Exchange in June 2023 at $22 per share.

It has become one of the hottest IPOs (initial public offerings) in the last year with the shares soaring to around $92 equating a three-fold return for investors. The valuation of the business has gone stratospheric. A market capitalisation of $10.4 billion implies a $33 million value on each of the firm’s 323 restaurants, equivalent to around 10-times revenue.

For comparison, the popular Chipotle Mexican Gill (CMG:NYSE) is valued at $3 million per restaurant and fast growing Wingstop (WING:NASDAQ) is valued at around $6 million per restaurant.

The company reported first quarter revenue up 30.3% to $256.3 million driven by 86 new store openings and same stores growth of 2.3%. The group turned a net profit of $14 million compared with a $2.1 million loss in the same period in 2023.

At the restaurant level net profit was $64.6 million, equivalent to a margin on sales of 25.2%. The fast-growing group expects to open 50 to 54 new stores in fiscal 2024, generate same store growth of 4.5% to 6.5% and achieve restaurant level margins between 23.7% and 24.3%. Management has a long-term goal of operating 1,000 restaurants by 2032.

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