Don’t Go Bargain Hunting in Consumer Stocks

by Tim Melvin | February 20, 2014 2:10 pm

I am starting to see a strong trend developing among consumer-oriented companies. Revenue growth is slowing and profits are falling and it looks like many consumer stocks have hit the financial engineering wall at last.

For the past couple of years, consumer stocks have relied on buying back stock, firing people and closing stores to show profit growth even as revenues declined. If you look at the retail reports so far this earnings season, it seems that they have run out of tricks, and a fairly bleak picture is emerging. Consumers are being very cautious and keeping their wallets closed tightly as the economy continues to struggle.

We have seen two very weak job reports, and that doesn’t bode well for consumer spending going forward. Unless we start seeing healthy job creation, the outlook for the retail and consumer staples segment is not very good, and investors should probably be lightening up on most of these stocks and avoid the temptation to buy them at these levels. In order for business to improve, the employment situation has to improve and that does not appear to be in the cards right now.

Anyone who thought retail problems where confined to troubled companies like JCPenney (JCP[1]) and Sears (SHLD[2]) may be in for a rude awakening. Even the bigger and best-run retailers are having difficulty growing earnings and revenues right now.

The Walmart (WMT[3]) report tells the story for the average retailer right now. The company reported a 21% decline in earnings and the fourth consecutive quarter of sales declines at Walmart stores open at least a year. The company cited higher taxes, a reduction in government programs like food stamps and tighter credit as primary reasons for the decline. The company said it expects the headwinds to exist for some time, and WMT stock lowered guidance for next quarter and the full year 2015.

It gets worse when you look at stores selling discretionary items. Best Buy (BBY[4]) has seen its shares fall by 37% so far this year as fourth-quarter sales were lower than expected. Conns (CONN[5]) said this week that sales of electronics and appliances were weaker than expected and profits would be well below expectations. The stock fell by more than 30% after the announcement. GameStop (GME[6]) has seen its stocks fall by more than 25% in 2014 as a result of sluggish holiday sales of video games.

In spite of these declines, the stocks still aren’t cheap. Best Buy is trading at 2.2 times book value and roughly 10% above my calculation of intrinsic value. Conns shares trade at more than 3 times book value and are roughly 20% above my fair value calculation. GameStop is at 1.9 times book value and right at its intrinsic value. Not only do these companies face difficult conditions their shares are not cheap.

Retailers, especially those that sell discretionary items, face headwinds that do not appear to be reflected in their stock price. I do not think it is time to try bottom fishing in this sector just yet.

As of this writing, Tim Melvin did not hold a position in any of the aforementioned securities.

Source URL: https://investorplace.com/2014/02/consumer-stocks/

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