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| | Street Patrol
Retailers ring up big profits; 3 stand out
Despite strong sales and earnings, many investors have been scared away from the sector by the prospect of rising interest rates. But consumers won't suddenly stop spending.
By Robert Walberg
While most companies already have reported first-quarter results, the retail industry is just stepping to the plate. Over the next two weeks, 40 retailers will report revenues and earnings. Bolstered by healthy tax rebates, a favorable calendar (Easter fell in March), tight inventories and a strengthening economy, 36 of the 40 retail companies are projected to post year-over-year earnings gains, with the average jump being an eye-opening 55.8%.
Retailers expected to ring up the biggest gains include J.C. Penney (JCP, news, msgs), American Eagle Outfitters (AEOS, news, msgs), Sharper Image (SHRP, news, msgs), May Department Stores (MAY, news, msgs), Childrens Place (PLCE, news, msgs), Federated Department Stores (FD, news, msgs) and Nordstrom (JWN, news, msgs). The four companies that apparently failed to resonate with consumers last quarter were Payless ShoeSource (PSS, news, msgs), Jo-Ann Stores (JAS, news, msgs), Big Lots (BLI, news, msgs) and The Wet Seal (WTSLA, news, msgs).
Considering the scope and breadth of the sectors performance, you would think that investors would be giddy with anticipation. But thats where you would be wrong. You see, a strange thing is happening in the retail sector. Despite the rosy first-quarter earnings picture and three consecutive months of strong chain-store sales numbers, the Morgan Stanley Retail Index ($MVR.X) has lost 6.2% of its value since peaking in early March. By comparison, the S&P 500 ($INX) is off by only 3.4%.
Based on the performance of the stocks, its clear that the Street expects consumers to rein in spending in the current quarter. Experts point to higher interest rates and higher fuel costs as two reasons why cash registers will ring less often in the weeks and months to come. Comparison periods also start to get a little tougher in the second half of the year.
Can't keep consumers down
However, if there is one thing Ive learned over the last 17 years as an analyst, its that it rarely pays to bet against the American consumer -- especially not when money is cheap and the economy is expanding. I doubt the modest rise in long-term interest rates over the past several weeks will keep junior from plunking down $20 or $30 for a T-shirt at Hot Topic (HOTT, news, msgs) or Pacific Sun (PSUN, news, msgs); men from dropping $100 on power tools at Home Depot (HD, news, msgs) or Lowes (LOW, news, msgs); or women from parting with $80 for that sexy new top from bebe stores (BEBE, news, msgs) or Nordstrom.
As for the argument that higher fuel prices will result in lower mall traffic, Im not buying it. People may forgo long road trips or air travel, but an extra 10 cents per gallon at the pump is unlikely to keep consumers from traveling five miles to the mall. In fact, if consumers skip that big vacation because travel costs are too high, maybe some of that money will find its way to the local shopping center. Where the effect might be real is on the lower income families that bear a higher burden from the gas price hikes. If true, that could spell some trouble for discounters such as Wal-Mart (WMT, news, msgs), Target (TGT, news, msgs) and Costco (COST, news, msgs).
Basically, theres no good reason for investors to shy away from the retail sector ahead of the upcoming earnings barrage in which the news is going to be resoundingly bullish. To the contrary, the markets unnecessary angst is creating a golden opportunity for investors to snatch up some real retail bargains.
Pacific Sunwear a shopping bargain
One such bargain is Pacific Sunwear. Like most of the sector, shares of Pac Sun have pulled back in recent weeks amid the general concern over rates. The stock also suffered due to anxiety over recent management changes. Just one week before the company named a new president of its Pac Sun division, the firm announced early last month that its chief financial officer, Carl Womack, would retire later this year.
Any time a company experiences several top management changes investors have a right to be worried, but the bottom line is that Pac Sun continues to shine. By selling trendy, well-made, brand-name, attractively priced clothing and accessories to the active teen to mid-20s market, the company has seen sales and earnings explode over the past several years.
Based on my recent walk through the Chicagoland Pac Suns, theres no sign that business is slowing, either. Tees, shorts (and were talking short) and jeans (priced to move at two pair for $55) were flying off the shelves. If these visits were any indication of the companys broad nationwide performance, Pac Sun is well-positioned to post its 24th straight month of same-store sales gains. Investors should note that 11 of the last 12 months saw double-digit gains.
Despite the impressive sales figures, Pac Sun trades at a modest 17 times earnings. Given the companys ability to generate top- and bottom-line growth of 20% or better, theres room for moderate multiple expansion. At 20 times current year estimated earnings, or one times its growth rate, Pac Sun has upward potential to $25+.
2 more for bargain hunters
Another company that caters to the teen and young adult market, and that looks attractively priced at current levels, is Abercrombie & Fitch (ANF, news, msgs). Like Pac Sun, Abercrombie has had its own internal problems. Though the company hasnt suffered the loss of key management personnel, it has had to recover from the brouhaha created by its racy marketing campaign. While the companys clothing still leaves plenty of skin exposed, its new magalogue is now more conservative.
Operationally, business remains relatively strong. Abercrombie still sports some of the highest margins in its group. Additionally, sales at its Hollister line have been strong, and the parent companys mens division -- which has gone back to more basic styling -- is showing signs of recovery. At 13.4 and 11.9 times current and next years projected earnings, the stock trades at a considerable discount to the market, its peers and its long-term growth rate. Back out the more than $5 per share in cash on hand, and the multiples look even more attractive.
The third bargain among the retailers set to report next week is Kohls (KSS, news, msgs). After an incredible 10-year run in which sales grew at a compounded annual rate of 23% and the stock rose by leaps and bounds, Kohls stock has lagged the group and the market badly over the past year amid a series of merchandising missteps that has resulted in sluggish sales, excess inventory and increased markdowns. But Kohls is addressing these concerns by launching a number of new product lines (Urban Pipeline and apt. 9) that will bring its merchandise more in line with current fashion trends. Look for the introduction of these lines, and the retooling of its Sonoma and Croft & Barrow brands, to revitalize sales growth and bolster margins.
Kohls currently trades at a relatively modest 1.38 times trailing twelve-month sales and 19.3 and 16.0 times estimated earnings, with a long-term growth rate projected at 20%. Though the stock isnt exhibiting much momentum right now, this is a classic turnaround story waiting to happen. Patient, value-oriented investors are likely to be rewarded to the tune of 25% or more as the company gets its merchandising mix and its growth story back on track.
At the time of publication, Robert Walberg did not own or control shares of any of the stocks listed in this article.
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