Retailers brace for gloomy holidays, gloomier '08

Penney expects fourth-quarter same-store sales to decline in the low-single digits.

NEW YORK (CNNMoney.com) -- Following Wal-Mart and Macy's, J.C. Penney on Thursday became the latest retailer to warn that housing, gas prices and credit woes will dent 2007 holiday sales and stifle discretionary spending in 2008.

Penney's warning is especially troubling because retail analysts had picked the chain to be one of the standouts during the holiday season, citing its unique merchandise and competitive prices.

"We're in a very difficult selling environment," J.C. Penney CEO Myron Ullman told analysts Thursday in a conference call to discuss the company's third-quarter results. Ullman said he expects a weakening sales environment to continue into 2008.

J.C. Penney's (Charts, Fortune 500) stock fell more than 5 percent Thursday after the department store chain reported a 9 percent drop in its third-quarter profits.

"We came out of September expecting a strong start for early fall. That didn't happen. This is the first time that we're seeing a real change in consumer sentiment," Ullman said.

He blamed weak housing conditions, mortgage and credit market concerns, and what he called the "psychological effect of fuel prices" for eroding Penney's profit and sales last quarter.

More importantly, the retailer warned on its full fiscal-year profit, saying that it expects crucial fourth-quarter same-store sales, which measures sales at retail stores open at least a year, to decline at a low single digit percentage.

Fiscal year profit is now forecast to be between $4.63 and $4.78 a share, down sharply from the previous guidance of $5.50 a share. Analysts had expected the retailer to earn $4.85 a share for the year ending in January.

The fourth quarter typically accounts for more than half of merchants' annual profit and sales.

Earlier this week, Home Depot (Charts, Fortune 500) and Wal-Mart (Charts, Fortune 500) both signaled their concern about a spending slowdown in the months ahead and into 2008. Penney's rival Macy's (Charts, Fortune 500) cut its fourth-quarter same-store sales estimate Wednesday.

"The outlook expressed by Penney and earlier by Wal-Mart and Macy's signals that consumer spending is slowing relative to the beginning of the year," said Wayne Hood, analyst with BMO Capital Markets.

Based on these weak holiday sales forecast and more to come, Hood said he's "almost written off the holiday season."

"The holiday shopping season will be over in three weeks. I'm more concerned about what the guidance from retailers for next year," he said.

"Most retailers will have a very guarded outlook for 2008. I expect conservative sales and inventory guidance for next year. If retailers cut back on spending on IT (information technology) projects, cut travel budgets and tightly control their discretionary budgets, then that could have a direct impact on the economy," Hood said.

To his point, Ullman said Penney was planning very conservatively on expenses for next year. "We won't be aggressive on spending in discretionary projects," he said.

Ullman said Penney's mall-based stores were particularly impacted by a steep drop in traffic during the quarter.

Ullman said having great merchandise and prices wouldn't matter if consumers curtailed their spending in the months ahead. Besides economic factors, Ullman said unseasonable warm weather hurt cold-weather apparel sales in the third quarter.

The gloomy forecast cast a chill on the retail industry.

"After hearing one of the more dramatic reductions in earnings and cash flow forecasts we've seen in some time, we no longer expect Penney's credit profile to improve," Carol Levenson, analyst with bond research firm GimmeCredit, wrote in a note Thursday. The firm downgraded Penney's debt to "stable" from "improving."

"We still expect [Penney] to outperform its peers, but clearly its market segment is getting hit inordinately by the consumer environment," she said.

Marshal Cohen, chief retail analyst with NPD Group, agreed that consumers were hesitating with their spending. "I don't think consumers will pull the plug on spending but they're not seeing anything new this year that they have to have," Cohen said.

Ullman said Penney will offer deeper holiday discounts in order to boost fourth-quarter sales, adding that he expects gross margins to decline as a result of increased promotions.

"We have to maintain a flow of fresh merchandise through the season," he said. "It's still early in the holiday season. The weather is more seasonable now so we'll see how consumers respond to that."

Going into next year, Ullman said Penney still intends to stick to its growth plan of opening 50 stores a year.

"But we will look at each year based on market conditions and opportunities in real estate," he said. He also said Penney would modify its inventory orders for next spring based on sales trends.

Bernard Sosnick, analyst with Oppenheimer & Co., hasn't changed his "buy" rating on Penney despite the warning.

"Relative to Macy's performance and other mall-based retailers, Penney's results weren't terrible," Sosnick said. "Penney's apparel sales are good, it had a 6 percent jump in back-to-school sales. Where it took a hit was in sales of big ticket items and home goods."

"How much weather was a factor, we don't know. It's also hard to determine how much a consumer spending slowdown was a factor," Sosnick said. "Yes, retailers are speaking cautiously about the holidays. Retailers respond quickly to trends. They will batten down the hatches to ride through the coming storm."

For his part, NPD's Cohen believes retailers are more optimistic about the holiday season than they are letting on.

"I think we are being set up for lower expectations. Revenues will see low growth, but it's still growth. Profits will suffer because everyone will cuts prices to get sales going. But that's OK because companies will just blame the economy for why profits didn't come," Cohen said.