Major retailers sustain capital expenditures despite higher interest rates

This story is part of our collaboration with CFO Brew on changing retail investing strategies.

As Federal Reserve Chairman Jerome Powell said earlier this month after announcing that the central bank wasn’t planning on lowering rates anytime soon, the purpose of a strict monetary policy is to put “downward pressure” on economic activity.

JPMorgan explains it this way: “When the central bank increases interest rates, borrowing becomes more expensive. In this environment, both consumers and businesses might think twice about taking out loans for major purchases or investments.”

In other words, higher rates should make it harder to obtain loans, which should make it harder to fund investments in your business, whether that’s a new store or a new technology. But looking at retailers specifically, this trend is not so clear-cut.

While department stores and apparel companies such as Express and Macy’s are shuttering locations and struggling under excessive debt loads, other major retailers such as Walmart and Aldi are planning ambitious store expansions and technology investments.

Watch out for the big boys: So where do interest rates factor into these very different outcomes? Samuel Rines, macro strategist at WisdomTree, told Retail Brew that it depends on variables such as size and cash flow.

“You’ve seen both Amazon and Walmart actually increase on the margin their outlook for capital expenditures,” he said. “For the big boys, it’s just not an issue whatsoever.”

He added that this is because “they’re generating a tremendous amount of cash flow” and don’t need capital markets to finance their expansions.

Amazon CFO Brian Olsavsky said during an earnings call last month that “we anticipate our overall capital expenditures to meaningfully increase year over year in 2024, primarily driven by higher infrastructure capex to support growth in AWS, including generative AI.” He also said the company saw its “highest free cash flow ever” in 2023, and that those trends continued into Q1.

Singing a similar tune, Walmart CFO John David Rainey last quarter said the company generated $35 billion in operating cash flow in 2023, up nearly 24%, and that it plans to invest 3%–3.5% of sales into capital expenditures over the next couple of years.

The little guys: But for those retailers that aren’t sitting on a massive cash horde, the current rate environment is having more of a direct impact: “If you only have one location, and you don’t have a diversified revenue base or a broad revenue base, and you have significantly high interest rates, you’re probably not going to open a store this year,” Rines said.

Sharon Miller, president of business banking at Bank of America, said in a statement to Retail Brew that due to uncertainty around interest rates, “most business owners are taking the time to re-evaluate their business plans and identify critical areas of need for their business,” and that “expansion plans are slightly down for small business owners.”

One way the impact of higher rates is felt is through increased rents. Small retailers that are trying to build new freestanding stores are the most susceptible, according to Geno Coradini and Walter Wahlfeldt, managing directors of retail leasing at JLL, a commercial real estate firm.

Expensive rents: In response to this situation, Coradini explained that some retailers have transitioned away from the common built-to-suit model, in which they collaborate with a developer to building a store customized to their needs.

“Retailers traditionally didn’t use their own money,” Wahlfeldt said. “They would work with the developer and say, ‘There’s this spot. I want it. I’ll lease it from you if you buy it, build my building, and then I move in and pay rent.’”

The problem with this approach is that developers tended to pass on their cost of capital, “which is typically borrowed,” and that “translates into a higher rent,” Cordini said.

As a workaround, some retailers are using their own capital to build stores, but as Cordini noted, “it’s not necessarily their strong suit to go out and build ground-up new construction.” But for companies that can’t afford that option, they are adopting what’s called fee-based development, where they pay a flat fee to the developer to minimize exposure to interest rates, but retains all stakes and interest in the real estate.

Why would developers accept this arrangement?

“It’s better than no deal,” Walhfeldt said.