by Will Ashworth | April 9, 2014 10:33 am
Barron’s ran a story this past Friday suggesting consumer discretionary ETFs could benefit from a sector rebound.
While consumer discretionary stocks have achieved extraordinary results over the past five years — the Consumer Discretionary Select Sector SPDR (XLY) annualized total return is 26.7%, seven percentage points higher than the SPDR S&P 500 (SPY) — consumer discretionary stocks were the worst-performing equity sector in the first quarter.
Suffering from a moribund shopping environment made worse by terrible weather, discretionary stocks have fallen more than most sectors in 2014. But that means now is a great time to consider these three consumer discretionary stocks to buy on the rebound.
There are a total of 86 consumer discretionary stocks in the XLY. The three largest weightings by industry are media, specialty retail, and hotels, restaurants and leisure at 30%, 18% and 14% respectively.
In the media industry, there are several options in XLY’s top 10 holdings. Of those my favorite by a country mile would have to be Disney (DIS), whose five business segments all grew year-over-year in its first quarter.
And the future looks incredibly bright for DIS stock. In March, I suggested the company is in great shape and that long-term investors were wise to buy because there are lots of growth drivers for DIS stock at the moment. As long as its media networks continue to generate single-digit revenue and operating income growth combined with sufficient growth from its four lesser lights — Parks and Resorts, Studio Entertainment, Consumer Products, and Interactive — DIS stock should have no problem doubling over the next 3-5 years.
When it comes to consumer discretionary stocks worth owning, DIS stock is the best in media.
Urban Outfitters’ (URBN) namesake brand stumbled down the stretch in the past year, delivering a same-store sales decline of 0.6% for the entire fiscal year. However, as a company, it delivered some pretty good news at a time when many consumer discretionary stocks related to specialty retail were losing their shirts.
Its billion-dollar brand, Anthropologie, increased same-store sales by 10.1% in fiscal 2014. It now accounts for 41% of overall revenue for URBN stock. In fiscal 2015, the company plans to open between 35 and 40 stores, including 13 from Anthropologie. With 511 stores open at the end of January, it’s taking a wait-and-see approach to business, and that’s a good thing. There will be plenty of time to grow once retail is on stronger footing.
In the meantime, it’s still making a decent amount of money. The company as a whole had operating profits of $429 million this past year to go along with its $3.1 billion in revenue. Its gross profit margin increased 70 basis points to 37.6% while its operating margin improved by 40 basis points to 13.8%. Generating more free cash flow than it ever has, it’s on par with Gap (GPS) while far superior to Abercrombie & Fitch (ANF), Aeropostale (ARO) and American Eagle Outfitters (AEO).
Recently, Urban Outfitters opened Space Ninety 8, a really interesting loft conversion in the Williamsburg area of Brooklyn. While only a concept store like the one it opened in L.A., it’s the kind of activity that indicates that the creative juices continue to flow in Philadelphia. For this reason, I expect URBN stock to benefit from the impending rebound in retail.
The choice here comes down to Chipotle Mexican Grill (CMG) and Starbucks (SBUX). Of the two, CMG stock is definitely doing better in 2014, up 4.2% year-to-date through April 4, almost 13 percentage points higher than SBUX. However, when I consider Starbucks’ business model, I have to go with the world’s largest coffee retailer.
CEO Howard Schultz appeared on CNBC back in January after Starbucks released its Q1 fiscal 2014 highlights. Schultz was very upbeat about SBUX stock and the company’s future. Although Starbucks’ same-store sales growth of 5% came in below expectations, Schultz reminded viewers that e-commerce has changed the way retailers should be judged by investors.
The emphasis on social media and technology to engage customers is something that Starbucks does very well. I’m a frequent visitor to its shops. Its loyalty program, while giving me many free coffees over time, has likely also led me to spend more than I otherwise would have. And that’s okay, because it’s one of my only indulgences in life.
Beyond what Schultz has said, I’m most excited about its move to serve beer and wine in thousands of stores across the country. Starbucks Evenings (4 p.m. to close) will allow the company to produce meaningful revenue from the slowest part of its day while still maintaining a cafe atmosphere.
The revenues generated by Starbucks Evenings will dramatically increase the four-wall contribution by each participating which in turn will have a tremendous impact on future profitability. Of the three consumer discretionary stocks to buy described herein, SBUX stock is the most intriguing over the long haul.
As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.
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