TheChek News Flow

With high-end goods makers keen to sell more directly to consumers, the business model desperately needs a makeover

Speculation that Saks Fifth Avenue would buy rival Neiman Marcus has been rife ever since the latter filed for bankruptcy during the pandemic. The deal to bring together North America’s two leading luxury department stores finally happened this month. But help came from an unexpected source: Amazon.

The ecommerce giant is among those backing the acquisition of Neiman Marcus Group by Saks’s parent company HBC for $2.65bn, including debt. Amazon and cloud-based software company Salesforce will be taking minority stakes in the newly formed business, to be called Saks Global. 

It is far from clear whether having two tech heavyweights on board will be enough to revive the ailing department store business model. Amazon’s role, initially at least, would most likely be to provide tech and logistics expertise.

Before that, US regulators would have to allow the deal to go through. They are already suing to block the $8.5bn tie-up between Coach owner Tapestry and Michael Kors’ parent Capri Holdings.

On paper, combining Saks and Neiman makes sense. Both cater to a similar high-end clientele and have many overlapping locations. Merging their warehouses, offices and back-end operations should yield quick savings. There are also benefits of scale. The new company, which is expected to generate $10bn in annual sales, would have 75 main stores as well as 100 off-price outlets. That should give it more negotiating power with brands and vendors.

Still, department stores are a tough business. Sears, JCPenney, Barneys New York, Lord & Taylor and Century 21 have also filed for bankruptcy in recent years.

Those that are still standing are struggling. At the remaining publicly listed department stores, credit cards — rather than retail sales — now generate a surprisingly large chunk of profits. Credit income accounted for about 47 per cent and 66 per cent, respectively, of Nordstrom’s and Kohl’s operating income last year, according to Bank of America Global Research. At Macy’s, the figure was about 55 per cent in 2022, said Citigroup.

Selling luxury goods to big spenders does offer some protection from the pullback in spending among lower- and middle-class consumers. But top luxury goods makers such as LVMH, Kering and Prada want to sell more directly to consumers. Shoppers now have multiple ways to buy directly from their favourite luxury labels, including through the brands’ own stores or websites.

The department store business model desperately needs a makeover. Even with Amazon’s backing, Saks and Neiman have their work cut out.

The board has failed to deliver — bring in the Special Administrators

The epic of the UK’s largest water company has rivalled Moby Dick for water, difficult situations and a desperate hunt for successful outcomes.  It no longer looks possible for the company to remain under the current ownership, or fully in the private sector.  The reason is simple: it hasn’t delivered on its promised investment.

The regulator recently announced its draft determination of the returns that water companies will be allowed to earn on their assets (https://www.ft.com/content/6087dea0-6ec0-40bd-831e-6a0f9ca91cd0).  There was plenty of bad news there for Thames Water.  But there has, or had, always been a narrow path to survival.

It never looked easy.  Success would depend on significant infrastructure investment and, moreover, on that investment being conducted under conditions of radical transparency.  One would then have to face MPs and the public, and commit to putting the entire investment programme on the internet in real time.  Sector specialists could comment and journalists could write pieces discussing problems as they arose.  The public would see progress as it happened and understand why and where there were delays.

As it occurs, the levels of investment approved by the regulator, although substantial, are much less than the companies requested. In ordinary circumstances, this would raise a question: why is the regulator allowed to reduce investment requests at all? I would change the regulatory framework such that the regulator can only do that if it can show a) the investment is not needed (no chance of that) or b) the investment does not represent good value for money (no reason to suspect that).

But these aren’t ordinary circumstances. As the Guardian reports, 108 of the projects agreed in the previous five year by Thames Water as part of its Asset Management Programme (AMP) have not been delivered. Many of the previous public objections have been spurious: but this is a serious problem, of a different level to the other known issues.

Until now, the allegation that excessive dividends have been paid has damaged Thames Water’s reputation, but never represented an existential threat. After all, the regulator sets the allowed return to equity and debt — and the level of equity is not munificent at something like 4 per cent real.  

Now, there are ways that the outturn returns to equity can exceed that level.  These are roughly as follows:

How would a water company cheat? One way is to deliver upgrades for less than was assumed. If that happens, it can keep the leftover money (or allow it to flow through to shareholders as a reward).

Previously, when cheating of that type was suspected to have occurred, it was not on a level that could be shown rigorously — ie, to legal standards — to have occurred.  There was lots of moaning about dividends, but that’s not the same thing. It may well be possible to show that the companies have failed in their legal duties on wastewater discharges, but that is complex: the companies can argue, for instance, that climate change has caused them problems. As a result, that process has not yet resulted in an outcome, negative or otherwise.

The upgrade failure is different. The company has admitted that it did not deliver. They spent the money but haven’t finished the work. In effect, they’ve been paid for work that they haven’t done.

This is qualitatively distinct to the other manifold failures of the company, because delivering the AMP upgrades is not optional. There is no question legally about whether it is optional. There is no defence. 

Sure, the company seeks to offer one when it says that the failure to deliver was “driven by macroeconomic conditions and a change in scope for many of the projects.” But this will not wash. Macro changes are a paradigm example of equity risk. The entire point of privatising something is to transfer risks like this to the private sector. Similarly on the change in scope, that’s something which was within the company’s control: if it chose to increase scope, it will have to pay.

The failure to deliver on the agreed infrastructure upgrades results in twin insoluble difficulties for the company.  Firstly, it can no longer argue that it has not cheated in how much it has returned to equity.  Secondly, it can no longer plausibly offer the public a major and transparent investment programme, because people can say “you didn’t do it last time.”

This can and should be a termination event for the entire current management.  The simplest way to achieve that would be through the appointment of Special Administrators, which is a step beyond the “special measures” regime the government seems to favour, but also short of full nationalisation and therefore much cheaper for the Treasury.  In any scenario, the whole board should go now.

Latest drop in consumer prices adds to expectations that Federal Reserve will cut rates at September meeting

The US Federal Reserve has become more confident that inflation is moving back down to its 2 per cent target, the central bank’s chair said on Monday, in the latest sign that it is preparing to cut interest rates.

Speaking at the Economic Club of Washington, Jay Powell appeared optimistic about a drop in inflation signalled in last week’s consumer price index report, which showed price pressures were easing in the US.

“Our test has been for quite some time that we want to have greater confidence that inflation was moving sustainably down towards our 2 per cent target, and what increases confidence in that is more good inflation data,” said Powell. “And lately, we have been getting some of that.”

The Fed chair also referred to the last three monthly inflation reports, which he said reflected “a pretty good pace” of price growth. They were preceded by an unexpected resurgence of inflation in the first quarter of the year which pushed back the timing of when the central bank would begin cutting its benchmark policy rate from its current level of 5.25-5.5 per cent.

Markets do not expect the Fed to reduce rates at its upcoming meeting at the end of the month but Powell’s comments will reinforce expectations that it is preparing to lower borrowing costs when it meets in September.

Powell declined to comment about the timing of the rate move, but has previously said policy decisions would be made “meeting by meeting”.

However, he was among the Fed officials who last week began laying the groundwork for a rate cut, citing better than expected economic data and a greater awareness of the potential effects to the labour market if borrowing costs were kept too high for too long.

The US unemployment rate, while still historically low, has ticked up in recent months and hovers at 4.1 per cent. But wage growth has slowed as monthly job gains have moderated, leading officials to frame the risks to the outlook as “two-sided”.

However, Powell on Monday said that a so-called hard landing, in which the unemployment rate jumps as inflation returns to target, is not the “most likely or a likely scenario”.

Asked about the trajectory for rates over the longer term, Powell said that the “neutral” rate — a level that neither stimulates nor suppresses growth — had probably risen, suggesting that rates would settle at a higher level than before the pandemic.

Gapping down
In reaction to earnings/guidance:

Other news:

Gapping up
In reaction to earnings/guidance:

Other news: