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2023 Q1 Consensus Forecast Presentation HdL Companies.pdf [1.85Mb]
Uploaded Thursday, 16 November 2023 by Jim Brashears

HdL presents an update on California’s retail economy based on current 1st Quarter 2023 data. Download the presentation deck to follow along with the recording. 

Related Resource: California Sales Tax Trends & Economic Drivers Report with Beacon Economics

 

Overview of Q1 2023 Results

In the first quarter of 2023, the data showed a 1.1% decline in sales on an adjusted basis. This decline was influenced by factors such as weather impacts, particularly in the building and construction industry, which saw a significant drop of 9.7%. Fuel and service stations also experienced an over 8% decline statewide. The overall trend indicated a decrease in sales tax dollars going into the pool.

Inflation and sales taxThe Bay Area was the only region that saw a 1.2% increase in sales, while other regions in the state showed a slight pullback. The discussion surrounding the results focused on topics such as inflation and pricing. Unlike the previous 18 months when sales tax increased alongside rising inflation and prices, the current decline in sales was attributed to pricing not increasing as much due to inflation. The impact of interest rates and consumer spending, particularly with the resumption of student loan payments, were also considered.

Savings and disposable income showed a gradual recovery from the pandemic-induced decline, with personal savings rates stabilizing. The forecast indicated a cooling off in durable goods sales compared to the dynamic growth experienced earlier. The Federal Reserve's decision to raise interest rates was seen as an effort to control inflation, but it was expected to have a dampening effect on dynamic growth.

Looking ahead, the second quarter was anticipated to continue the decline, with an expected total decrease of around 2.5%. The fiscal year 2022-2023 was predicted to remain positive but with a slight decline. The following calendar year was projected to see quarterly declines before recovering to a more normal growth rate of 2-3% in fiscal year 2023-2024.

Economic Forecast considerations 2023 HdL Companies

The presentation also discussed the breakdown of sales between local places of sale and pool allocations, with the former experiencing significant growth during periods of inflation but now facing a slowdown. The pools had already begun to show a slowdown, and further details on them would be provided by Tracy in the upcoming discussion. Overall, the outlook suggested a period of cooling off and then a return to positive growth in the future.

The Major Industry Groups

Autos

The auto industry has experienced various challenges recently, leading to a complex market. Despite a 10% decrease in actual auto sales in California, sales tax receipts for the category increased by 8%. This discrepancy can be attributed to high pricing pressures. Manufacturers focused on producing expensive cars, including luxury and electric vehicles, due to limited inventory caused by the pandemic. Consequently, there are fewer affordable options available, and consumers have been paying over the manufacturer's suggested retail price (MSRP).

Although the current inventory levels are historically low, there has been a slight increase compared to the previous year. Certain brands such as Toyota, Honda, Lexus, and Kia remain hard to find due to ongoing shortages of electronic components. However, other brands have seen inventory pile up, like the 2023GP Renegade, which reportedly has a two-year glut.

New car pricing has continued to rise, albeit at a decelerating rate, while used car prices have fallen by 12.1% over the past year. Dealerships are now becoming more competitive in pricing, which is beneficial for car buyers. This trend is expected to continue throughout the year. Notably, Tesla has significantly reduced prices for models like the Model 3 and Model Y, making them more price competitive with federal tax incentives.

Consumers are now paying below sticker price and MSRP, marking a shift from the past two years when they had to pay significantly higher prices. However, rising interest rates and financing costs pose challenges, considering the already high cost of cars. Despite these obstacles, the average age of cars on the road has increased for the sixth consecutive year, reaching 12.5 years. Eventually, consumers will need to purchase new cars, driven by the aging fleet and pent-up demand.

In terms of tax receipts, the forecast for auto dealers anticipated a turn to negative growth in 2023, but this decline occurred earlier than expected. The expectation of lower car prices is projected to continue for the next few quarters, impacting tax receipts. However, beyond 2023 and 2024, an increase in sales is expected due to the aging fleet and accumulated demand.

Fuel & Service Stations

The fuel and service stations industry has experienced significant changes in California. Fuel prices have seen a notable increase in the past year, but currently, prices are down by approximately 20%. California, known for its high gasoline prices, has been surpassed by Washington state in terms of cost. Despite OPEC's production cuts, fuel pricing has not been significantly impacted, indicating that market concerns revolve more around potential economic slowdown and rising interest rates rather than supply.

The forecast for the industry reflects the current 20% decrease in gasoline prices compared to the previous year. Actual results for the first quarter of 2023 showed a slightly higher decrease of around 8.6% compared to the projected 5% decrease. The expectation is for prices to continue declining throughout the year and then stabilize.

Building & Construction

The building and construction industry experienced a significant decrease in the first quarter, falling nearly 10%. The unusually wet winter played a role in this decline, but comparing it to historical data from a similarly rainy period in 1998 showed that building and construction receipts remained positive back then. The current market conditions, such as increased material prices, particularly lumber, also contributed to the decline.

Lumber prices experienced a significant spike during the pandemic but have since decreased by approximately 64% compared to a year ago. These material prices greatly influence the overall results of building and construction. The forecast anticipates that the worst of the lumber price declines has been seen, and there may be pent-up demand after the rainy first quarter. However, consumers are pulling back on home improvement projects, as there has been a shift in consumer spending habits.

Factors such as rising interest rates and increased uncertainty have also slowed the residential housing market. Although more infrastructure projects are expected, they won't fully compensate for the decreases in building materials and home improvement spending. The forecast predicts a modest dip in the category until the fourth quarter of 2023, after which growth is expected. Long-term prospects for the industry remain strong due to the significant housing shortage and pent-up demand for infrastructure projects.

Food & Drugs

The food and drugs category had a relatively flat performance in the quarter, with a modest gain of about 0.3%, falling short of the projected 2% growth. Grocery stores, which mainly include taxable consumables like paper towels and alcoholic beverages, showed solid positive growth of 5.5%.

However, the Food and Drug category was dragged down by the decline in cannabis sales for the fifth consecutive quarter on a year-over-year basis. The decline in cannabis sales can be attributed to factors such as oversupply in the California market and other states. Further details on the causes of this decline can be found in a linked paper provided later in the presentation.

Although the declines in cannabis sales have persisted for over a year, it is anticipated that the situation will improve as the market stabilizes. The expectation is for the growth rates to normalize and reach the more typical 2% growth in the future.

General Consumer Goods

In the first quarter, the general consumer goods category experienced a contraction of about 1.9%. Discount department stores, which make up a significant portion of this category, were down by nearly 1%. However, there were a couple of bright spots, including family apparel stores with a growth of 2.3% and specialty stores driven by the beauty and pet sectors with a 4% growth.

The decline in general consumer goods was evident across various categories such as home furnishings, jewelry stores, and women's apparel, suggesting that higher earners are spending less on designer brands. Instead, consumers are seeking better deals and allocating more of their spending towards experiences rather than material possessions.

The slide also indicates that consumers are trading down in certain categories like food and grocery, household consumables, and apparel, opting for store brands and better value for their money. However, the beauty industry continues to thrive as consumers are willing to trade up and spend more on beauty products.

Looking ahead, the general consumer goods category, excluding discount department stores, is expected to continue its decline in the near term, remaining flat with low to no growth over the next year and a half. Economic uncertainty, interest rates, and changing consumer spending habits contribute to this projection.

State and County Pools

The pools, which are part of the Bradley Burns sales tax, play an important role in local sales tax revenue. They receive indirect allocations based on the percentage of Bradley Burns growth for each quarter in a county. The implementation of AB 147, the marketplace facilitator law, led to a significant increase in local tax revenue for the pools. General consumer goods make up the largest tax group within the pools, and there was a massive growth in this category during the pandemic, fueled by online purchases and the influx of out-of-state sales tax dollars.

However, there has been a shift in the allocation of pool revenue. Many general consumer goods dollars are now being directly allocated to agencies instead of going through the pools. This shift is primarily due to fulfillment centers being considered places of sale, resulting in direct allocations to agencies with fulfillment centers. As a result, the allocation for general consumer goods in the pools has declined, while other pool categories have seen around 3% growth.

Direct allocations have been increasing compared to indirect allocations, with more money coming out of the pools and going into the business and industry group, where fulfillment centers are categorized. The business and industry group has shown a 4% increase in pool revenue, while general consumer goods experienced a 7.1% decline. Building and construction also saw a slight increase of about 3.5% in pool revenues.

In terms of the pools forecast, a contraction was expected as revenues shift to direct allocations. The pool revenue in the first quarter of 2023 was down by 1.1% but was projected to be positive by 1% in line with the previous quarter. The contraction happened sooner than anticipated, and a reduction in pool revenue is expected through the end of the current calendar year, with limited growth projected for the following year.

The shift of revenues out of the pools into direct allocation is largely driven by fulfillment centers, and this trend is likely to continue in the foreseeable future.

Business & Industry

The business and industry category is receiving a significant amount of money from tax revenue. The largest group within this category is fulfillment centers, which accounts for about 27% of the revenue. Fulfillment centers have experienced significant growth, especially since the implementation of AB 147, the marketplace facilitator law. The shift of revenues from the general pools to fulfillment centers has been ongoing, with additional fulfillment centers being treated as places of sale. 

Apart from fulfillment centers, the business and industry category encompasses 21 different business types, ranging from agricultural equipment to motion pictures. The top 10 business types include medical biotechnology and garden and agricultural supplies. However, these sectors have seen contractions in spending, with a 7% contraction in medical biotech and a 19% drop in garden and agricultural supplies compared to the previous year. This indicates a pullback in spending in these areas.

Fulfillment centers are expected to continue growing as online sales companies adjust their business models to improve product delivery. This will lead to more orders being filled from local stores and direct allocations to the agencies with fulfillment centers. The Institute for Supply Management Manufacturing Index, which is studied for the industrial part of the business and industry category, has shown a 7-month consecutive contraction in the first quarter, with a 16.4% decrease compared to the previous year. This decline is attributed to dropping new orders and backlogs, higher borrowing costs, and difficulties in acquiring capital for investment.

The forecast for business and industry remains positive, with an anticipated 2% growth each quarter in the upcoming fiscal periods. This category is not experiencing the same negative trends seen in other groups.

Restaurants & Hotels

In the first quarter of 2023, spending on restaurants and hotels increased by 9%, despite a decline in lunch visits likely due to hybrid work-from-home models. Fast food chains offering value meals have seen an increase in sales tax revenue as people look for deals. The leisure and entertainment industry is also seeing a resurgence, with more spending on experiences and a rebound in the hospitality sector due to tourism. The forecast for restaurants and hotels predicts continued growth of about 4% for the rest of the calendar year and 3% thereafter.

Looking at cash receipts in the food services and drinking places category, there has been a 6.36% growth in April and May, indicating a positive trend for the restaurant industry. Although there has been a slight pullback compared to the previous quarter, overall growth for 2023 is estimated to be 2.2%. The forecast for the fiscal year 2023-2024 shows a slight decline of about half a percent, but it is still within a range of plus or minus 1%, suggesting a cooling off period rather than a recessionary pullback by consumers.

The economy is considered stable with signs of a positive outlook, and while future fiscal years' growth cannot be predicted with certainty, it is expected to return to the historical range of 2-3%.


 

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