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Dig deep for luxury retailing gems
Two high-end retailers already have disappointed investors, and others could follow. But Coach and Brookstone could still reward investors.
By Robert Walberg
First Tiffany (TIF, news, msgs) and now Saks (SKS, news, msgs).
In less than a week, these two high-end retailers have surprised investors with disappointing earnings.
Luxury retailers were expected to post strong results this holiday season as an improving economy and buoyant real estate prices led to increased consumer spending on high-ticket items. But after examining the reports from Tiffany and Saks, investors must be questioning whether they should continue to pay a premium for other high-end retail stocks such as Coach (COH, news, msgs), The Neiman-Marcus Group (NMG.A, news, msgs) and Nordstrom (JWN, news, msgs).
The good news, if there was any from the Tiffany and Saks reports, was that each company suffered from problems specific to their businesses. Tiffany cited softer-than-expected sales in Japan and higher raw materials prices for its lackluster results. Saks blamed its shortfall on this summers hurricanes in Florida and on store closings. In other words, neither company hinted at a general spending slowdown that would hamper the sector's results.
So investors shouldn't rush out and dump their luxury retail stocks, though some have such lofty valuations that any sales or earnings shortfalls would punish them. Most evidence gathered from credit card companies and retail chains suggests that consumers continue to spend and spend freely. Point in fact, same-store sales, a key indicator because it tracks sales at stores open at least a year, have risen in the two months leading up to the holiday season. That's traditionally a good sign of whats to come.
Early warnings?
The stocks of Tiffany and Saks had been trending lower throughout the year, in sharp contrast to most of the industry. Tiffany is down more than 30% on the year, while Saks is off by a more modest 10%. By comparison, the average year-to-date gain posted by Coach, Neiman Marcus, Nordstrom and Brookstone (BKST, news, msgs) is an impressive 32%. This divergence suggests that investors were anticipating the troubles at the two companies. And lets face it -- you dont have to be a genius to realize that higher precious metals prices would have an adverse impact on Tiffanys bottom line, and that widespread store closings would crimp the sales effort at Saks.
Related retail resources on MSN Money
But the gains for the rest of the group mean investors need to be choosy when picking stocks in the sector. Some luxury retail stocks are beginning to look as pricey as the merchandise sold in the stores. Thats not reason enough to sell, but it should give investors pause. With an average forward price-to-earnings ratio (based on expected fiscal-year 2005 earnings) of 19.8 times, Coach, Neiman Marcus and Nordstrom must continue to deliver sales and earnings growth that meets or exceeds expectations for their stocks to climb higher. At these premium prices, a failure to deliver for any reason will result in punishment by investors.
Of these three, the one most likely to avoid disappointment is Coach, which makes handbags, briefcases, weekend and travel accessories and the like. Based in New York, the company has strung together an impressive run of sales and earnings growth that shows little to no signs of slowing down. A trip to any of its stores shows why. Coach once was for high-end consumers only, but now the stores are littered with high-school girls buying handbags, shoes and accessories. By keeping price points at the lower end of the luxury range, Coach has managed to broaden its customer base. The company also has plenty of room for growth because it has just 174 stores nationwide.
Though its sales and earnings multiples are the highest in the industry, these figures are supported by industry-best profit margins and returns on equity. The company also has little debt and is cash flow positive. As long as Coach merely hits its top- and bottom-line targets, the stock should have little trouble running to the $55 to $57 area.
Still attractive
Another stock in the luxury group that still looks attractive, even after advancing by 39% already this year, is Brookstone. Its earnings are expected to jump by 38% this fiscal year and by another 18% next fiscal year. Despite such heady growth, the specialty retailers forward P/E ratio of 16.1 and 13.6, based on fiscal 2005 and 2006 estimates, are well below the sector and the market. Its price-to-sales ratio (based on trailing 12-month sales) of 0.87 and price-to-earnings-to-long-term-growth ratio of well below 1 also suggest that theres still plenty of value in this stock. A break of its June high of $21 would leave the stock positioned for a near- to intermediate-term run at the $25 to $26 range.
Nordstrom, meanwhile, is more worrisome. The department store chain continues to improve its product mix and profit margins, something that showed up in its fiscal third-quarter earnings release this week. It reported a 71% surge in profits and delivered same-store sales growth in the quarter of 8.1%, well above expectations. Nordstrom also guided fiscal 2005 profits higher, saying it expects to earn $2.68 to $2.73 a share, up from $2.46 to $2.53 a share.
Despite the higher guidance, Nordstrom's earnings growth is expected to slow over the next year. In addition, the stock trades at a steep valuation, more than 18.5 times estimated earnings, which puts it at the upper end of its historical range. These issues suggest that theres not much upside potential left in the stock. The same goes for Neiman Marcus.
Investors also ought to be careful before falling into a value trap at Tiffany and Saks. Sure, the stocks have fallen because of what might be temporary problems, possibly making them value plays. But youd be wise to sit back and see how the companies top brass address the problems before rushing back into either stock. Tiffanys struggles in Japan, its second biggest market, and Saks' ongoing restructuring effort are more serious problems that could weigh on stocks for months to come.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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