Discount stores racking up customers

We remain positive about off-price retailers, as we think the pullback in consumer sentiment could drive many consumers to trade down. The group has continued to gain share from trade-down customers as consumers’ budgets grow increasingly stretched from multiyear inflation pressures. We saw this in 2022, when discount retail spending grew faster than overall retail spending due to the onset of inflation (June 2022 inflation hit a 40-year high), prompting consumers to trade down to value-based retailers.

Off-pricers continue to gain share from retail bankruptcies, department stores and traditional retailers. We expect this to be a long-term driver, as younger customers value the ease of off-mall shopping as well as a “treasure hunt” experience. Off-price retailers continue to grow square footage by a low- to mid-single-digit percentage annually, and we expect this to continue. A large amount of white space remains in apparel and other categories, such as home and accessories. Retail bankruptcies also provide access to product, vendor relationships and favorable real estate. We think this gives off-pricers runway to continue growing comps in low- to mid-single digits for the foreseeable future.

Off-pricers’ customer base has remained relatively stable, with outperformance in stores in both higher- and lower-income regions—a sign that the assortments are resonating with a wide variety of consumers. Lower-income consumers are most susceptible to food and gas inflation taking a larger share of the budget. Because inflation in these categories has remained relatively steady, we expect low- and middle-income cohort spending to remain stable. We also expect trade down from higher-income consumers to help offset impacts from trade-out at the lower end.

We view off-pricers as the most insulated from tariffs, given that most product is sourced in the U.S. We found that in 2018–2019, tariffs provided expanded product availability to off-price retailers due to increased disruption. Tariffs will likely lead to more canceled products as retailers walk away from shipments that land at higher-than-expected price points. For other products, retailers will try to pass the costs along to consumers, creating a higher pricing umbrella at competitors. This could allow off-pricers to pass along tariff-related costs. Off-pricers also benefit from a flexible buying model that favors maintaining a strong value gap with traditional retailers over offering a specific product.

We think off-price fundamentals will outperform overall retail in a macro slowdown. Off-price retailers outperformed the sector in both ‘00–’01 and ‘08–’09, as a great assortment of branded goods at a discount enticed wealthier shoppers to trade down. In 2022, off-price stocks recovered quickly post-COVID and outperformed the S&P, department stores and a group of consistent compounders. Given a high level of resilience in a wide range of economic conditions, we think the group is most likely to benefit in today’s uncertain macroeconomic environment.