Financial Crisis May Offer Retail Opportunities

The current United States credit crisis is unlikely to affect the expansion of Apple’s retail initiative, which has pumped out about 40 stores each year since the chain debuted in May, 2001. An analysis of the company’s financial statements reveals that the unavailability of credit and the government’s remedies may actually offer opportunities for Apple’s real estate team in the form of less-expensive property leases. The only downside to Apple’s plans may be any consumer spending downturn that results from bankruptcies and other company failures.

The current economic problems began with home mortgage defaults earlier this year, leading to losses at investment companies that bought up the loans from banks and other lending institutions over the years. Several other related industries were affected as the situation has grown more desperate, especially the real estate development industry that depends upon capital for land purchases, construction and mall acquisitions.

Apple’s retail exposure to the current financial squeeze seems neglible. First, the retail segment has been profitable in four of the last seven full years it’s been operating. So it’s been both contributing revenue to the company’s overall profit, while also paying for the segment’s operation.

Next, Apple has consistently opened just 30 to 40 stores each year, a rate described by Apple executives as “slow and measured,” and intended to insure the stores’ profitability. This means that the annual cost of opening new stores is much lower than some other companies who open hundreds of new locations each year, and the future stores are less likely to be cancelled in light of the current situation.

Apple will have at least 246 stores open by the end of September, a rate of about almost three stores per month since the chain debuted in 2001. The rate of capital expenditures has been a modest $100 million to $294 million over the past four years, during which 21 to 41 new stores were opened each year.

Apple also has a pricing advantage–they never cut prices to boost sales. While they do have seasonal product bundles that offer savings, the company doesn’t offer percentage sales, specials or other temporary discounts. So Apple’s customers are used to paying full price, and so never delay their purchases based on expected discounts.

Despite this moderation, Apple does have substantial contract obligations for its retail stores, in the form of lease commitments. The company tends to sign leases with longer terms than are typical for retail. According to its financial report, Apple’s 10 to 15-year leases now total $1.3 billion.

Apple’s key advantage during this period is an enormous reserve of $9 billion in cash, which can be used to fund outside company acquisitions, additional stores and other projects. The company also holds another $11.4 billion in short-term investments that’s available for projects.

Apple’s annual capital expenditures and lease commitments combined now total about $600 million a year. That represents just 3.3 percent of the company’s cash reserves, and nearly covered by the retail segment’s annual profit for 2007. Even more pertinent, those reserves are increasing each quarter: almost 20 percent per quarter over the past year, and has doubled over the last two years.

But does Apple really need to spend more money on its retail operation? Maybe not.

The credit crisis has slopped over into the real estate market, in particular the commercial segment that includes shopping and retail centers. An article in The Wall Street Journal notes that developers have overbuilt during the past eight years. Many developers have dropped future mall plans, are sitting on empty malls, or are discounting existing spaces to attract retailers.

The WSJ concludes, “For retailers, the glut can have an upside: cheaper rents, shorter lease terms and fatter allowances from landlords for outfitting stores.” And that’s where Apple’s cashflow and prestige stores could provide an advantage in negotiating lower lease costs or other benefits.

Apple’s favorite mall developers are definitely taking a hit, since their construction and upgrades are fueled by credit. General Growth Properties, which is property manager for 36 Apple stores, announced Monday they will take action to pay down $27 billion in debt, including selling off some properties. The company’s stock (GGP) fell 25 percent after the announcement. The stock reached $67 per share in early 2007, but has been in decline ever since.

Simon Property Group (36 stores) is the world’s largest mall owner by market value, and its stock has lost about 21 percent over the past 18 months. But the company declared a stock dividend at the end of August, and gave analysts a revenue and profit forecast for fiscal 2008 that is about 8 percent above 2007 results.

Australia-based Westfield Group (14) has seen its stock drop 22 percent since the start of 2007, as property revaluations have hampered the company’s performance. Profit for the first half of 2007 fell 35 per cent because of the dropping value of its properties, and revenue was down 32 percent. The company is depending upon its up-scale properties and long-term leases to maintain financial performance in the coming year.

The Macerich Company (16) stock has declined 36 percent since the start of 2007, but issued another dividend and forecast 2008 results at about 8 percent above the previous year.

Interestingly, analysts say that as General Growth sells off its properties, the company’s value may decline to the point where it becomes a take-over target by one of the other three companies listed here.

The only downside for Apple is the possible decline in purchases as the loss of jobs, home mortgage forclosures and other consumer-level actions affect America’s buying power. Today the National Retail Federation released their holiday 2008 sales forecast, saying sales will increase by 2.2 percent, below the 10-year average increase of 4.4 percent. The increase would represent the slowest growth since 2002, the NRF said.

The group explained, “A struggling housing market and rising unemployment accompanied by meager income gains will continue to hamper the consumer throughout the season.” They said food and energy costs would remain high. “With the current financial industry crisis continuing to chip away at consumer confidence, NRF does not foresee an economic turnaround until the second half of next year.”

However, Apple has consistently outperformed the rest of the industry, and its holiday quarter always provides the most revenue and profit. The retail stores are always jammed with customers during the holiday shopping season that begins the day after Thanksgiving. Apple even sets up special “grab-and-go” tables to expedite the purchase of iPods and laptops by the crush of visitors.

During Apple’s last conference call with financial analysts, executives said that there will be more international stores than usual opening during the coming quarters. That tactic itself may help mitigate against the U.S. financial troubles.