Say It Ain't So, Joe!

As slow recovery weighs on c-store customers, a few economic bright spots emerge.

By
Samantha Oller, Senior Editor/Special Projects Coordinator

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”Whatever happened to Joe?”That was the question David Nelson, professor of economic sat Western Washington University, and founder and president of Finance& Resources Management Consultants Inc., Bellingham, Wash., posed to attendees of the 2013 NACS State of the Industry Summit in his annual check of the economy’s vitals.

“I’m talking about Joe, who used to be a regular customer at the convenience store,” Nelson explained. “Then he stopped coming. We wondered: Did we do something wrong? Did we offend Joe?”

The question was actually the run up to a long joke, but it also reflects the state of c-store customers, beset by a slow, weak economic recovery as well as government financial moves such as the decision to let the temporary payroll tax cut expire, which hit low- and middleincomeconsumers hardest.

Also consider:

Growth in gross domestic product(GDP) has been only 2.1% per year—with output on a per-person basis 1.6 percentage points lower than five years ago, before the recession began, and well below the 3% rate that’s considered “normal.”

While the economy has added 5.5 million jobs since the employment low point during the recession, the laborforce continues to be down several million jobs, or up only one-half of the jobs lost from its past employment peak five years ago. It has been adding an average of 100,000 to 150,000 jobs per month, “certainly enough job growth to keep up with population growth,” said Nelson, but “it’s not enough to dramatically lower the unemployment rate.”

The unemployment rate is down almost 2 percentage points from its peak during the recession, but still 2 percentage points higher than what is considered “normal.”

On this last point, while the drop in unemployment could have raised the typical c-store’s in-store sales by 1.7%, or $1,500 per store per month, it failed to do so, largely because of a decline in the workforce participation rate. “If those people aren’t out driving, maybe they aren’t out shopping,” said Nelson. Indeed, by a show of hands, attendee sat the summit were largely pessimistic about the current state of the economy. But from Nelson’s vantage point, there are some reasons to be optimistic after the nation survived what he described as “a garden-variety severe recession.”

Bracing for Impact

First, let’s talk about that unemployment rate. Examining multiple measures, from those that do not include people who are temporarily out of work because they are transitioning between jobs, up to measures that include those who would like to work more hours, the unemployment rate has dropped year over year by at least one-half oaf percentage point. “So even though the recovery has been slow—that’s the bad news—we’re moving in the right direction, and there’s a lot of positive momentum going on in the economy, “Nelson said.

And the path of the direction is clear. As Nelson explained, while past recessions have typically followed a distinctive” shape, with the economic decline followed by a quick recovery, the Great Recession and those just before it followed “U” pattern.

“The economy has gone down but recovery has not been dramatic, and this time around it looks like a very, very slow recovery,” he said.

He cited the example of other countries that have gone through serious financial crises, as well as the United States during the Great Depression.

“The message is fairly clear: If we have a recession that is accompanied by a serious financial crisis, the outcome is much more painful than a normal garden-variety recession, and the recovery is much slower,” he said. In large part, this is because of the dramatic loss in the net worth of U.S. households. According to the last Federal Reserve survey of consumer finances, which is conducted every three years, the median U.S. family’s net worth dropped more than $49,000 from 2007 to 2010, with $35,000 tied to a drop in home equity.

Incomes also declined on an inflation-adjusted basis. In total, this clipped the average household’s spending by about $400 per month from 2007 to 2010. “Obviously that’s going to impact all sorts of channels of trade that are providing goods and services to the households in this economy,” Nelson said.

A Taxing Time

Then there is the issue of taxes. The American Taxpayer Relief Act of 2012, signed at the end of the year to avert the “fiscal cliff,” actually resulted in higher taxes for most Americans, Nelson said. The 2% temporary payroll tax cut for the average working Joe was allowed to expire.

This is likely to have a very significant effect on sales at c-stores and other retailers. A survey from the National Retail Federation found that 73% of consumers said their spending took a hit from the expiration of the tax cut, with 46% saying they would spend less overall and 36% expecting to be more value-conscious.“How do you position your promotions to value-sell to customers who have less disposable income, that are trying to figure out how to meet their needs and at same time making their incomes stretch?”Nelson said.

Separately, a survey by Bankrate.com found that only 30% of consumers said they would cut back on spending; 48% claimed not to notice a change after the expiration of the tax cut; and 7% said it won’t affect them at all.

“We have one element of society—the 2%—where it’s an annoyance, but it won’t impact their lifestyle because they are not as income-constrained as many folks at lower-income levels,” Nelson said.“How do you position your offer for what the customers’ needs are, whether they ‘rein the affluent end of the population where they don’t care, it doesn’t change their view, [or] a significant group that does care?”

For high-income earners, the American Taxpayer Relief Act of 2012 did raise the marginal tax rate from 35% to 39.6%;the tax rate on capital gains and dividends from 15% to 20%; and phased outcome itemized deductions and personal exemptions. However, high-income consumers also enjoyed a few tax breaks: For the estate and gift tax, a relatively generous provision that allows an exemption of $5 million, adjusted for inflation, and a tax rate in excess of 40%, was made permanent. So were the alternative minimum tax patch, marriage penalty relief and employer educational assistance plans.(For more tax credits and opportunities, see p. 43.)

With this in mind, c-store retailers have an opportunity to position their offering in a way that meets the needs of the less and/or more affluent, Nelson suggested, particularly in the area of foodservice. Dining out is commonly cited as the first area that consumers will cut when their budgets are pressured; here, c-store operators can position themselves as an economic alternative to casual chains, which have seen three consecutive years of declining sales.

“These customers who aren’t going to Applebee’s or Denny’s—they’re not exactly going home to peel a 10-pound pack of potatoes,” Nelson said. “They’re probably going to look for a lower-cost alternative to meet their needs, and I think the fast-food option and c-stores is one of them. So I don’t necessarily seethes as a negative for your segment, if you can capture the greater value proposition of these folks who are dining out less in a sit-down setting.”

The Cruelest of Cuts

The sequestration, which calls for cuts of $1.2 trillion in budget authority over nine-year period, is another considerable factor in the economic growth picture. For 2013, because the sequestration will apply only to seven months beginning in April, the budget authority cut is $85 billion, or $146 billion on an annualized basis. Because it is a budget authority, cuts may be something less this amount, although is would still be about 0.5% of GDP.

In essence, this will amount to about $50 billion in cuts for 2013, which is not huge relative to projected annual growth of GDP, the federal budget or estimated GDP. But it will affect the 10 million who are employed by the government or work as government contractors. According to the Congressional Budget Office (CBO), it equates to 800,000 fulltime-equivalent (FTE) cuts by the end of 2014.

“Actual cuts will depend on hours vs. jobs cut—for example, going to a fourday workweek vs. laying off workers, “Nelson said. “Regardless, when you look at government, which was an extremely stimulative force during the recession, as we had massive tax cuts and massive spending increases, we have to look at government as more of a restraining force on the economy as we go forward.”Based on analyses from Bank of America and Merrill Lynch, expect the biggest effect of the sequestration on GDP to hit during the second and third quarters of 2013, Nelson said: “We may be in a flat spot over the next six months.”That said, Nelson doesn’t consider the sequestration a total negative for the economy.“The world seems to be going on just fine,” he said, pointing out that shrinking public sector combined with a growing private sector is “a positive” for economic growth.

Long-Term Issues

Nelson also cited some issues and trends that may shape the economic picture in the long term:

Since 1962, entitlement spending has doubled and is growing dramatically. If demographic trends hold, it will go from representing 10% of GDP today to more than 18% by 2048. Historically, federal level tax collections are around 18% of GDP. Considering demographic trends and adding interest takes federal spending from 23% of GDP to 36% of GDP by 2037. “I personally think we don’t want the U.S. economy to have federal government spending … become that big of who we are,” Nelson said. “It would have a very stifling impact on economy growth and dynamism.”

Federal Reserve monetary policy, through its rounds of quantitative easing, has sought to pump massive quantities of money into the economy—or about $85 billion per month—to encourage growth, but not so much that it triggers inflation. The Fed believes the balance is healthy when unemployment is 5.5% to 6%, while long-term inflationism around 2%. Right now, inflation is running below 2%, and unemployment is not projected to hit 6% until the end of 2015. “What that means for us is you can assume the Fed is going to keep their easing monetary policy going for quite awhile more,” said Nelson.

Part of the Fed’s efforts are centered on encouraging greater lending at banks. Since mid-2008, bank deposits have surged, and banks are loaded with liquidity and starving for growth, Nelson said. They have started lending again, with business loans up 21% from second-quarter 2010 to third-quarter 2012, and bank commercial and investor loans up 16% in 2012.

“Banks are competing aggressively for your business, honestly on terms probably better than you’ve ever seen and on terms you may never see again, “Nelson said. “If you’re not borrowing now, I think you’re missing a huge opportunity.”

How will these moves affect the private sector? Household consumption is well above the pre-recession peak, and up 1% to 2% for the past few years—“not fantastic but not terrible,” Nelson said. Feeding the momentum is a recovery in home and stock prices, which had formerly held consumers back on big-ticket purchases. Just take a look at the auto industry, in which new car sales have recovered, to see signs of loosening up.

The housing recovery is positioned well, Nelson said, with housing permits up 34% and underwater mortgages down to 21.5% at the end of 2012. This has a direct effect on c-stores, when considering that three jobs are created for every new home that’s built, according to data from the National Association of Home Builders. Nelson, who facilitates retailer study groups, said that his study-group members describe construction workers as “great convenience-store customers.”

U.S. manufacturing is also recovering, and offering a better environment for growth for multinationals. While labor costs are growing 2% year over year, much of the developing world is seeing double-digit gains, which is narrowing the advantage, Nelson said. The U.S. business environment is also more stable, with fewer supply disruptions, greater synergies between development teams and producers, and low transportation costs. With the cost of oil up, shipping big freight overseas and back has become very expensive. At the same time, low natural-gas prices in the United States—one-third the global average—has set the stage for a fuel renaissance here.

Of course, energy is always a complex beast. Nelson highlighted the drop in gasoline demand, citing that his study group participants say dealers are seeing a 4% to 6% drop in same-store sales because of lower fuel sales. “How long can that go on and those dealers remain viable?” he said. “That’s a very significant challenge, and a question we have to consider.”

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