Our expectation of 8.5% holiday sales growth is well above the 3.5% average of the past 20 years. Our analysts across the retail and consumer teams estimated growth of 4%-11%, reflecting a mix of consumers' pent-up demand, price inflation, and supply chain constraints. The holiday shopping season is traditionally the most important sales period for the retail sector. This season represents a unique opportunity for retailers to benefit from consumers' eagerness to bring extra cheer (and gifts) to in-person celebrations. Only a few hurdles stand between retailers and a bonanza holiday: supply chain bottlenecks, labor shortages, cost inflation, and a potential fourth wave of the COVID-19 pandemic. We believe the largest retailers will reap most of the rewards.

Chart 1

November And December Holiday Total Retail Sales

Consumers are spending their accumulated savings, despite inflationary concerns.

October 2021 retail sales increased 1.7% from September 2021 and 16% year over year, according to the Census Bureau. We believe the positive retail numbers in October signaled consumers' good financial position and continued elevated demand for the upcoming holidays. The numbers also illustrate consumers' capacity to absorb most of the price increases retailers have implemented. We believe inflation has had only a modest effect on consumer spending in, for example, clothing, accessories and food service and drinking places. The flat month-over-month results in apparel and restaurants is likely also a result of supply chain constraints and labor shortages. As inflation filters into nondiscretionary items such as grocery, demand for discretionary categories such as apparel and dining out could soften. Still, consumers are spending above pre-pandemic levels, demonstrating their relative price insensitivity, and we expect this to sustain through the holiday shopping season.

Chart 2

Department stores and non-store (e-commerce) retailers, typically big beneficiaries of past holiday spending, performed well in October. In our view, consumers shopping early and absorbing price increases explain these significant gains. The largest players in these two retail channels (Macy's and Amazon) reinforce our confidence that large retailers are likely to navigate supply chain and inflation challenges better than issuers with less scale and operational sophistication (see "Labor And Supply Chain Woes Chill Retail Spirits For Holidays And Beyond," published Sept. 28, 2021 and "On Activists' Wish List: New Spin On Macy's And Kohl's This Holiday Season," published Nov. 15, 2021).

Chart 3

Consumers are shopping for gifts earlier than usual on fear of missing out on merchandise availability.

We think it is a seller's market because supply chain and inventory challenges are well-publicized and consumers are experiencing firsthand stock-outs and delayed deliveries. As retailers receive inventory, they are putting the merchandise on shelves, and consumers are buying out of fear that the merchandise will not be there if they delay the purchase. This behavior drives greater full-price sales, helping retailers limit promotions that they have historically been compelled to resort to because of competitive dynamics. Over the long term, we expect these competitive dynamics to return unless retailers learn from current supply chain constraints that lower inventory levels can be good for business.

Sales may rise, but profit margins depend on how well retailers manage costs.

Supply chain, labor inflation, and commodity costs are a trifecta of headwinds that could squeeze profit margins in the coming quarters. The magnitude of margin pressures depends partly on the size of the retailer. Although we believe consumers are in a good position financially, we don't expect retailers to be able to fully pass on their cost to consumers because that would risk alienating customers. As a result, we think larger players--including Walmart, Home Depot, and Target--will fare better, given their ability to partially offset increased labor and freight costs with efficiency gains. Similarly, pulling orders forward, chartering container ships, and other creative workarounds to the supply chain bottlenecks have enabled these retailers to stock up inventory in advance of the all-important fourth quarter. However, the downside risk is that if consumers become overly cautious during December--a scenario we don't expect--retailers could be left with excess inventory they would need to mark down. In this scenario, margins could be pressured even more than we anticipate. Smaller players may take a bigger hit to margins because they don't have the scale to absorb cost increases.

As consumers increasingly shop across channels, retailers who offer an attractive omnichannel experience may have more reasons to celebrate.

E-commerce sales will grow this holiday season, partly fueled by a heightened sense of safety and convenience while the pandemic lingers. We think the real holiday winners will be the well-positioned merchants who have invested in their omnichannel capabilities to provide convenience, improved delivery options, and an attractive merchandise offering. As consumers increasingly shop across channels, retailers with brick-and-mortar locations can also benefit from stronger online sales, given the growth of "buy online, pick up in-store" and "buy online, ship to store" options. Rising e-commerce penetration is usually accompanied by margin dilution as online orders cost more to fulfill and ship. Retailers who can maintain margins while providing a seamless omnichannel experience will have a better competitive position this holiday season.

Expectations are high for retailers to reel in holiday sales.

Despite ongoing supply chain and labor challenges, external analysts are forecasting a robust holiday season. We have consolidated a variety of qualitative and quantitative holiday sales forecasts and announcements (table 1). The various forecasts do not all measure the same definition of sales, but they reflect similar expectations of a very positive retail holiday season.

Table 1

Who (Really) Needs To Have A Happy Holiday?

We have an overall stable bias for rated retail and restaurant companies. However, we believe risk of missing out on a good holiday are higher for smaller retailers who could face some difficulties procuring inventory and have less room to manage cost inflation. We believe issuers with negative rating outlooks are at risk of downgrades if they cannot navigate cost inflation, supply chain constraints, and labor shortages (table 2 includes 2019 data, which we believe reflects more typical holiday results than 2020). Without a jolly holiday season, we could see incremental rating pressure for these retailers.

Table 2

Related Research

• On Activists' Wish List: New Spin On Macy's And Kohl's This Holiday Season, Nov. 15, 2021
• Labor And Supply Chain Woes Chill Retail Spirits For Holidays And Beyond, Sept. 28, 2021