Retail Sector Head Brian McGough's research shows that planned capex spending is expected be up 30% across the industry as you'll see from the chart below. Note that many companies that are on the lower end of the spending spectrum were big capex spenders in 2012.
McGough says capital spending comes just at a time when margins across the industry are the highest they have been in five years. McGough says this is not bullish for the sector: a haphazard approach to capital spending will drive down Return On Capital figures in the coming quarters and retailers will be under pressure to either drive margins still higher, or to show a major ramp-up in sales growth.
McGough says this is not a strategy of smart managers plowing profits back into their businesses, while managing investor expectations. “Retailers deploy capital when they can,” says McGough. “Not when they should.”
“Peak” profit margins are, by definition, unsustainable, and McGough sees this capital spending as a knee-jerk reaction, not a strategic allocation of resources. Wall Street analysts will now assume these peak margins are a “new normal.”
But Return on Capital will be substantially down in coming quarters. First, because “peak” is just that: the point before the decline. Second, because spending one-third more capital makes the denominator one-third larger, which results in a much smaller final number. Look for retailers to start reporting lower Return On Capital in coming quarters, causing analysts to go negative on some of today’s star players.