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| | Company Focus
5 reasons not to write off retailers
The deals this holiday season lie in companies that rely on keen fashion sense and well-managed inventory rather than markdowns. This year, our shopping list has 21 stocks.
By Michael Brush
Investors who fret that weary consumers are going to snap their wallets shut and kill the recovery need to take a closer look at the antics of Black Friday shoppers at a Wal-Mart store in Stratford, Conn., outside New York.
On the day after Thanksgiving, when most retail financial books turn from red to black for the year, eager bargain hunters there literally knocked a door off its hinges, assaulted employees and tried sneaking through loading docks to get the best deals. TV crews captured the mayhem on tape.
That kind of exuberance -- if not outright violence -- filled shoppers nationwide on Black Friday, helping Wal-Mart Stores (WMT, news, msgs) post the biggest sales day in its history -- $1.43 billion, up 14% from a year ago.
A weary consumer? Not likely. Indeed, some economists now argue analysts are wrong to write off consumers because they are out of work and up to their eyeballs in debt.
If theyre right -- and the Black Friday antics, though only anecdotal, suggest that may be the case -- you can expect pretty good holiday sales over the next three weeks. Such a trend should boost the shares of retailers, many of which already are turning in decent growth because theyre betting on the right fashion trends and smartly cutting costs.
These include stores such as The Gap (GPS, news, msgs), Chico's FAS (CHS, news, msgs), American Eagle Outfitters (AEOS, news, msgs), Coach (COH, news, msgs), Pier 1 Imports (PIR, news, msgs), Columbia Sportswear (COLM, news, msgs), Joseph A. Bank Clothiers (JOSB, news, msgs) and Shoe Carnival (SCVL, news, msgs).
Misplaced worries about the consumer
True, unemployment levels are troubling. But those who are still working are getting healthy pay increases of around 3% a year. Theyre also enjoying greater buying power.
Adjusted for declining prices, real wages are up an impressive 6% in the past year, says James Paulsen, an economist and market strategist for Wells Capital Management who has astutely called many of the turns in the economy over the past several years. Thats as much financial firepower as consumers have had coming out of almost any slowdown.
Worries about burdensome personal debt loads may be misplaced as well. Many economists calculate household debt rose 8% in the last year. But if you adjust for higher wages and higher home values -- the two biggest sources of funds to cover loans -- debt grew by only 2%. Thats about the lowest level of annual debt growth on record, Paulsen says.
Bears also like to argue that the consumer is tapped out, having already bought all the big-ticket items (cars, furniture and other pricey products available under low-interest loans) he could need. This suggests theres little of the pent-up demand that normally drives spending at the end of a slump.
But the bears are overlooking the pullback in outlays for non-durable goods and services, which makes up the lions share of consumer spending. Theyre running about 6% below normal. Factor that in, and consumer spending is roughly 3% below average, says Paulsen. That leaves plenty of room for a consumer snapback as confidence returns.
Will it? The chances are good because, on the macro front, policy makers earlier this fall finally moved beyond just interest rate cuts as a way to bring about growth. Now, a weaker dollar (which spurs exports), government deficit spending and lower long-term interest rates are lined up to produce more growth.
Paulsen, in fact, predicts the U.S. economy will grow 4% next year. Indeed, signs of strength emerged in a slew of economic measures released last week on employment, sentiment, spending and income.
Over the next few weeks, meanwhile, the funds from many of those home mortgage refinancings during the second half of 2002 are going to materialize right before Christmas.
It should all add up to at least 3% to 4% retail sales growth for the holiday season, predicts David Campbell, a retail analyst with Davenport & Co. in Richmond, Va. Unfortunately for investors in retail stocks, much of that growth will come as a result of sales discounts that eat into profit margins, he points out.
To find the retailers that are managing to increase profits despite the cost-cutting environment, we scanned the IBES database for the stores with the best upward earnings-estimate revisions. Thats a signal their sales strength really is translating into profit growth, and that the trend is likely to continue. Then we identified five positive consumer spending themes -- and a few to watch out for.
A warm welcome for colder weather
Excessive snow cover in parts of Siberia is reducing the amount of the suns warmth that the Earth retains. That will contribute to below-normal temperatures east of the Mississippi over the next few months, predicts meteorologist Judah Cohen of Atmospheric and Environmental Research in Lexington, Mass.
Thats great news for apparel retailers. Theyve been dutifully stocking cold-weather clothing for the past few winters, only to see warm weather kill demand. This year may be different.
People will be opening their closets and noticing that theyve seen whats in there for the past two or three years and decide it is time for a new look, says Kurt Barnard, publisher of Barnard's Retail Trend Report. The change will be particularly good news for apparel retailers, because cool weather clothing carries higher profit margins.
Specialty apparel companies with solid upward earnings-estimate revisions include Chicos FAS, Gap, Kenneth Cole Productions (KCP, news, msgs), Columbia Sportswear and Gymboree (GYMB, news, msgs), which sells childrens clothing. Another is Joseph A. Bank Clothiers, a mens clothing store thats bringing costs down by purchasing more of its inventory overseas, says Lee Molendyk, an analyst with Insight Capital Research and Management in Walnut Creek, Calif.
Discounters still have appeal
Consumers will continue to favor bargains because of uncertainties about the economy. Among the obvious discount store plays such as TJX Cos. (TJX, news, msgs), Target (TGT, news, msgs), Dollar General (DG, news, msgs) and Kohls (KSS, news, msgs), only Kohls has solid upward earnings-estimate revisions.
Less-obvious players in the discount niche with strong earnings growth include: Shoe Carnival, Payless ShoeSource (PSS, news, msgs) and Cost Plus (CPWM, news, msgs), a home products retailer.
Shoe Carnival is on better terms with many of the major athletic shoe companies, so it now has wider access to popular merchandise at lower prices. Payless has increased sales by stocking more fashionable womens shoes. It plans to do the same in mens and kids shoes. Cost Plus caters to value-oriented customers looking for home furnishings. As a small chain, it has plenty of room to build on its popularity.
Home improvement, no; home furnishings, yes
Housing market growth continues at a sharp pace, but not all home-oriented retailers will benefit. John LaForge, an analyst with the Phoenix-Hollister fund company in Sarasota, Fla. is cautious about Home Depot (HD, news, msgs) and Lowes (LOW, news, msgs) because theyre both rapidly expanding in a cutthroat battle for market share. Instead, he favors value-oriented home furnishings retailers such as Pier 1 Imports and Kirkland's (KIRK, news, msgs). A microcap home retailer with solid earnings trends is Bombay Co. (BBA, news, msgs).
Plays in niche and teen retailers
Two specialty retailers that continue to turn in good profit growth despite the slowdown are Coach and PetsMart (PETM, news, msgs). Coach sells luxury handbags and leather accessories priced below Gucci and Prada brands. Because of the popularity of its brand, the company posted impressive double-digit sales growth in the most recent quarter compared to a year before, says Susie Hultquist, an analyst at Liberty Acorn Funds. Coach is also expanding aggressively into Japan. Sales there, about 15% of the business, are expected to grow by more than 50% next year.
PetsMart, which sells pet food and supplies, is a turnaround play in the middle innings. The company has been drawing more consumers by converting shops from a warehouse layout to a more customer-friendly format, says Tim Miller of Insight Capital Research and Management. Behind the scenes, better inventory management is improving profitability. The chain is also beginning to offer services like grooming, training and kennels, which bring higher profit margins.
Teens profitable but hard to pin down
Many teen-oriented retailers are hitting the fashion trends right, judging by recent results. The ones with the best profit trends right now include American Eagle Outfitters, Aeropostale (ARO, news, msgs), Abercrombie & Fitch (ANF, news, msgs), Pacific Sunwear (PSUN, news, msgs), Claire's Stores (CLE, news, msgs), Urban Outfitters (URBN, news, msgs) and Quiksilver (ZQK, news, msgs).
Investors should remember that teens are fickle, and when they turn on a product, the damage to shareholders can be heavy. Shares of Wet Seal (WTSLA, news, msgs), for example, have lost 50% since the summer, to trade down around $12 because of a fashion miss. Another example: Tommy Hilfiger (TOM, news, msgs) shares are off 80% to about $8 since the teen apparel retailers heyday in the late 1990s. Privately held rivals such as FUBU and Phat Farm have stolen business, says Morningstar analyst Roz Bryant.
Retailers to avoid
Consumer electronics retailers such as Best Buy (BBY, news, msgs) and Circuit City (CC, news, msgs) may have overexpanded just as Wal-Mart and Target are starting to move in on their turf. Warehouse clubs such as Costco (COST, news, msgs) and BJ's Wholesale Club (BJ, news, msgs) are also beating each other up by building too many new outlets in a battle for market share.
Traditional department stores such as Federated Department Stores (FD, news, msgs) and May Department Stores (MAY, news, msgs) continue to see sales shrink, thanks in part to competition from JC Penney (JCP, news, msgs) and Kohls. They also continue to focus too much on widely recognized brands at the expense of more trendy labels.
Like many retailers, the traditional department stores also suffer because they built too much capacity in recent years. Analysts at J.P. Morgan Chase estimate that per capita retail mall space hit an all-time high recently. Thats good for shoppers, because it means many retailers will have to offer sales as they close down capacity. For investors, it means you have to stay with the niche retailers that are hitting the trend right or taking steps to bring costs down by overhauling stores and distribution. Otherwise, even if you avoid getting stomped by Wal-Mart crowds rushing for the bargains, your savings at the cash register will be wiped out by your losses in your retail investments.
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