Seven ways to profit from retailers
With consumer spending undermined over the past year by a crashing economy, massive layoffs and plunging home prices, investors have been concerned about the financial health of retail stores. At the start of the second-quarter earnings reporting season, conventional wisdom believed that low-priced retailers would do well, while luxury retailers would suffer because consumers focused on price and needs.
Second Quarter Report Card
Most retailers have now reported their fiscal second quarter earnings. To investors’ relief, earnings have not been as bad as feared. Offsetting sharp declines in sales with store closures, inventory cuts and other cost-cutting measures, most retail stores beat second-quarter earnings forecasts.
While industry earnings declined for the ninth consecutive quarter, the 8% decline in second-quarter earnings year-over-year was less than half the magnitude estimated at the depth of the recession at the end of March.
There were also some surprises. Discount Wal-Mart (WMT) reported boring results, while competitor Target (TGT) beat analysts’ forecast by nearly 20%. In the high-end retail sector, Nordstrom (JWN) reported earnings in line with analysts’ forecast, while Saks (SKS) lost less than feared.
Among building materials retail stores, Lowe’s (LOW) disappointed, while Home Depot (HD) did not. In department stores, Kohl’s (KSS) posted a profitable quarter, while JC Penney’s (JCP) results broke even. Dillard’s (DDS) bled red ink at a slower rate than forecast, as same-store sales declined for the 12th consecutive quarter.
What awaits retailers and retail stocks
Revenues from the retail industry appear to have stabilized, albeit at a low level. Retail stocks measured by the S&P Retail Index (RLX) have risen nearly 24% since January. 2 topping the 12% gain of the S&P 500.
Many retail industry bosses are cautious in their outlook. There are few signs that consumers are rapidly increasing their discretionary spending. Unlike previous recessions, consumers do not depend on credit cards to finance their expenses. On the one hand, consumers are reducing their leverage and saving more of their income. Second, financial institutions have raised credit standards and lowered credit limits.
The back-to-school shopping season has been relatively subdued thus far. However, there may be some hope here, as several states go on “tax holidays” this weekend.
On the bright side, retail stocks also have a few factors going for them.
Year-on-year sales comparisons for retailers will get easier in the coming months. Retailers won’t have to keep up with sales boosted by last summer’s stimulus controls. Also, the sharp drop in retail sales that fell during the fourth quarter of last year should help comparisons.
Following positive surprises in second-quarter earnings, analysts have raised their full-year earnings forecast for many retailers.
Investors with a healthy dose of risk appetite can find some attractive opportunities in the retail landscape.
Two mutual funds
Mutual fund investors can look for no-load funds like Fidelity Select Retailing (FSRPX) and Rydex Retailing (RYRIX).
Three ETFs
In the ETF arena, SPDR S&P Retail (XRT) is a popular choice among investors. Other options include PowerShares Dynamic Retail (PMR) and Merrill Lynch Retail HOLDRS (RTH). Technically, RTH is a publicly traded trust unit.
Two actions
Investors looking for stock ideas might consider furniture retailer Kirkland’s (KIRK) and discount retailer 99 Cents Only Stores (NDN). Both companies that have put together an impressive series of positive earnings surprises in a challenging retail environment. KIRK and NDN are retailers who go through Zack’s stock screen for ‘Two in a row 10% or more positive surprises’. KIRK is trading at a forward P / E of approximately 15, while the less volatile NDN shares change hands at a forward P / E of 19X.