Given this earnings backdrop, and looking ahead to next week’s Black Friday event, we asked InvestorPlace contributors to pick the one stock in the retail stock they’d choose if they could buy only one. Their answers may surprise you.
Go Upmarket in Any Market
By John Jagerson and Wade Hansen
Editors, SlingShot Trader
When it comes to retailers this holiday season, keep your eye on the higher-end competitors.
U.S. consumers are sick and tired of cheap. They want to splurge a little bit. Consider Walmart (NYSE:WMT) and Target (NYSE:TGT), both of which reported earnings this morning. Walmart is the bargain-basement discounter whose stores offer a depressing shopping experience, while Target is the well-groomed provider of inexpensive items displayed in clean, wide aisles and served by helpful staff. See the difference?
Consumers can’t stand the sterile, low-cost alternative any more. Sure, they may just be buying toilet paper and groceries, but they want to feel respected and cared for while they’re doing it. That’s why Walmart’s earnings only rose by 9% last quarter and revenue fell short of expectations, while Target’s EPS rose by 15% and the company raised expectations for the current quarter.
Taking a step up the retail ladder, consider JCPenney (NYSE:JCP) vs. Macy’s (NYSE:M). JCPenney is still trying to rebrand itself as the “hip” alternative to boring department stores, but many consumers haven’t gotten the memo yet. Macy’s, on the other hand, continues to shine as a high-end department store focusing on service and providing name-brand items you can’t find anywhere else. That’s why JCP stock is down 26.50% this quarter and M stock is up 2.23%.
Bottom line? If you’re looking for higher-end returns in the retail sector, focus on the higher-end retailers this holiday season.
Home Depot Is Building on a Strong Foundation
After many false starts, the recovery in the housing market looks to be real this time. And that makes Home Depot (NYSE:HD), the nation’s largest home-improvement retailer, almost too obvious an idea. After all, when everyone is chasing the same trade or investment, it’s often too late to find value.
But there looks to be plenty more upside ahead with Home Depot, despite the eye-popping 46% gain year-to-date (vs. 8% for the S&P 500).
Yes, housing has finally gone from being an anchor to an assist for Home Depot. But equally important is that the retailer is better able to capitalize on that housing tailwind now that it’s wrung greater efficiencies out of its supply chain and product mix.
Not only are sales and same-store sales expanding smartly against some tough year-ago comparisons, but more of those sales dollars are finding their way to the bottom line.
Indeed, over the past four years, Home Depot’s operating margins have expanded to about 10% from 6%, according to James Ragan, an analyst at Crowell Weedon, who rates share at “buy.” Those fatter margins have added approximately $3 billion a year to operating income.
True, with a forward price-to-earnings ratio of 18, shares trade at a premium to their own five-year average of 17, according to data from Thomson Reuters Stock Reports. But then the housing market tanked in 2006 and the market wasn’t exactly willing to pay up for a home-improvement retailer over that span.
That looks like it’s about to change.
“In our opinion, HD’s leading market position, dominant margin performance, and ability to benefit from a housing recovery can drive higher multiples,” says Ragan in a new note to clients.
His peers agree. Analysts’ median price target stands at $69. Add in the 1.8% yield on the dividend, and Home Depot’s stock has an implied upside of 14% in the next 12 months or so.
By Jeff Reeves
Editor, InvestorPlace.com and The Slant
Online travel retailer Priceline.com (NASDAQ:PCLN) may not seem like a wise pick in lean times, but big growth overseas and strong positioning as a low-cost option for consumers are two big reasons to give this pick a look.
The appeal of Priceline — beyond the William Shatner factor, of course — is that most travelers now use this site (or ones like it) as the default way to book trips, hotels and rental cars for both vacations and business trips. And while tough economic times mean less travel, they don’t mean no travel.
Consider that while many retailers have had lackluster fundamentals over the past few years, PCLN has seen a simply stunning 15 straight quarters of year-over-year revenue growth dating back to the Great Recession. Profits are up in eight consecutive quarters. These results are due to big growth at home but also in foreign markets — Priceline now operates in about 100 countries and over 40 languages.
Priceline has a reasonable forward P/E of about 16.5 — not unheard of in specialty retail, particularly for a high-growth stock like this. Shares are up more than 30% in 2012 and a dramatic 500% in the last five years, so there is a real risk of overheating, but thus far the music hasn’t stopped; Q3 earnings were very strong and the company is expecting 15% to 20% growth next quarter, too.
Big Growth Potential in Five Below
By Tom Taulli
Teen retailer Five Below (NASDAQ:FIVE) came public in mid-July at $17 and quickly shot up to $40. But since then, the shares have come down to about $29. True, the valuation is still a bit frothy, with a forward price-to-earnings ratio of 42. But the company’s growth potential remains strong.
As the name implies, Five Below sells its apparel at $5 or lower. The company uses a sophisticated sourcing infrastructure as well as opportunistic purchases of excess inventories, focusing on maximizing sell-throughs. Each store location has sections that are divided into “worlds” like Style, Party, Candy and Seasonal.
The formula has worked out quite well — a new store location has a payback period of less than one year.
So it should be no surprise that Five Below has been on a tear. From fiscal 2009 to 2011, net sales grew at an average rate of 54.1% and operating income grew by 95.3%. Comparable-store sales growth has also been strong, coming to 10.4% in the latest quarter.
Five Below has 199 locations, most of them on the East Coast — there is much more room for expansion. Indeed, the company plans to expand its store base to more than 2,000 locations over the next two decades.