U.S.merchants tighten belts along with consumers

American retailers are becoming as frugal as their shoppers, cutting expenses to maintain stable profits through what is increasingly looking like another challenging holiday season.

Wal-Mart Stores Inc. reported a 3.6% gain in second-quarter earnings Tuesday and raised its annual profit forecast, despite notching negative sales at U.S. stores open at least a year for the fifth consecutive quarter.

"The slow economic recovery will continue to affect our customers, and we expect they will remain cautious about spending," Wal-Mart Chief Executive Mike Duke said. Yet Wal-Mart executives cited a silver lining: while Wal-Mart sales were slow, expenses were rising more slowly.

Home Depot Inc. reported a 6.8% quarterly profit jump despite a moderate same-store sales boost of 1.7%, and also raised its full-year profit forecast, even as it lowered annual revenue projections.

"How in the heck can you increase earnings with tighter revenue? The answer is that we expect some expense relief," said Home Depot Chief Financial Officer Carol Tome. The company has been hiring more part-timers, with fewer vacation days and benefits, as sales slowly return.

The results provided fresh evidence that top retail chains are adapting to the prolonged economic slowdown by reducing employee work hours, maintaining bone-thin inventories, squeezing costs out of supply chains and finding other ways to match consumers' belt-tightening.

Still, retail-industry experts say store chains will find it harder to pull off the balancing act as the year grinds on.

Earnings comparisons get tougher in the second half of the year as they will be matched up against late 2009 when stores performed significantly better than the year before. Yet the two-headed monster weighing down consumer confidence high unemployment and low home prices shows no letup.

"It's going to be a rough road for retailers," said Ken Perkins, president of research firm Retail Metrics. "The economic indicators are not conducive to a spike in consumer spending, which is what we'd need to see."

Similar to rival Home Depot, Lowe's Cos. reported a surge in profit on Monday of 9.6% and said it was raising its annual profit forecast while also lowering annual revenue projections.

"The economy is not as strong as we anticipated, and the jobs picture continues to be a negative factor," said Chief Executive Robert Niblock, adding that he now believes the housing market won't rebound until the middle of 2011, six months later than he had expected.

Though retail executives have been planning conservatively for months, many had expected the economy to show signs of improvement by this point in the fiscal year. Absent a surge in spending retailers report that consumers in the current back-to-school season are buying only what they need retail executives are now counting on cost reductions, not sales growth, to power profits.

The attitude adjustment is being driven by consumers such as Connie Cody, a stay-at-home mom of two small kids who lives in Sacramento, Calif. Ms. Cody spent about $250 getting her daughter ready for kindergarten, with most merchandise purchased at marked-down prices.

"I am doing whatever I can spending carefully, frugally, until we ride out this storm," she said, adding, "People are still out of a job."

Abercrombie & Fitch Co. plans to close 60 of its 1,098 stores this year and 50 next year. The teen retailer reported a 5% jump in quarterly same-store sales, but noted that average prices fell 15% as stores wage price wars to wrest a bigger share of back-to-school budgets.

"We're prepared and plan for an aggressive promotional environment," said Chief Executive Mike Jeffries, who expects price competition to continue through the holidays.

Urban Outfitters Inc., the apparel company for twenty-somethings that also operates Anthropologie and Free People, voiced similar cautions.

"I am not bullish about the second half," said Chief Executive Glen Senk, even as the company reported a net sales increase of 20%. "We're facing a slow and lengthy recovery that will be punctuated by periods of uncertainty."

Saks Inc. said Tuesday it was closing luxury department stores in Plano, Texas, and Mission Viejo, Calif., after reporting a quarterly loss of $32.2 million. "The macro recovery will be slow and fragile," said Chief Executive Stephen Sadove.

Even discounter TJX Cos., which has seen revenue rise at its T.J. Maxx, Marshalls and HomeGoods stores as consumers trade down to cheaper merchandise, conservatively predicted second-half same-store sales would be flat to down 1%.

"There is a lot of potential volatility," said Chief Financial Officer Jeff Naylor.

While Wal-Mart managed another quarter of solid profit due to international growth and cost controls, the world's largest retailer admitted it was tweaking some strategies that flopped.

New U.S. stores chief Bill Simon said Wal-Mart was cutting advertising budgets and resuming its traditional "every day low prices" strategy after aggressive temporary "rollback" price cuts failed to stimulate new sales. Executives also said Wal-Mart was restoring the "action alley" piles of merchandise pallets to its aisles after an effort to pare back assortments went too far.

And with Wal-Mart's lower-end customers still suffering to make ends meet at the end of pay periods, the company said it planned to stock smaller product sizes to fend off competition from fast-growing dollar stores.

"We're going to help them with that problem," said Chief Financial Officer Tom Schoewe.