Black Stocks for Black Friday

Retail stocks have been some of the best performers during the past few months. Big-box retailers are reporting solid results, and investors seem sold on the idea that Black Friday and the holiday shopping season will bring even more cheer to the sector.    

I hate to be a Grinch, but I think this optimism is misplaced. There is still a recession going on in the real world, unemployment is high, the Philly Fed just dropped its GDP forecast to 2.2% from 2.8%, and inventories are piling up again, according to the Empire State Manufacturing Survey. This economic reality has prompted a structural change in consumer spending habits that I call the New Frugal.    

I’ve put together a list of five retail stocks that are due for a fall. In addition to faltering fundamentals, the charts are against them. The options trading picks I am recommending expire in January 2011 or beyond, but please don’t hang on to the bitter end. If you make a profit before expiration, do not hesitate to cash in.    

    

Retail Stock to Short – Abercrombie & Fitch (ANF)

Trendy teen retailer Abercrombie & Fitch Co. (NYSE: ANF) specializes in half-naked models and overpriced clothes. Hey, who says the models actually have to wear the clothes to sell them? With their $100 jeans and $40 T-shirts, this retailer was one of the hardest hit by the pullback in consumer spending.    

To boost sales, the company decided to sacrifice margins by cutting prices. However, I believe ANF will have to discount too much to make it a decent holiday season. Even their “sale” prices are ludicrous. Come on, $30 for a cotton tee, you’ve got to be joking. And this holiday season there will be plenty of competition from more reasonably priced retailers vying for the dollars of cash-strapped parents and teens.    

Current Price: $48
Downside Target: $33 in 3-6 months
Trade: Buy ANF February 2010 Puts 

   

Retail Stock to Short – American Eagle Outfitters (AEO)

American Eagle Outfitters (NYSE: AEO) caters to the same demographic as Abercrombie & Fitch, but its prices are a bit more reasonable. I’ll emphasize “a bit,” and wonder aloud why the more holes a retailer puts in a new pair of jeans the more expensive they are.    

Anyway, even with its lower prices, the company is struggling. October same-store sales fell 2%, which surprised the Street given that the consensus estimates were for a gain of 1.4%. Analysts happen to be feeling all warm and fuzzy about better-than-expected Q3 earnings from retailers and expect this good cheer to continue. AEO will likely see sales increase in November, but overall I think the holidays will disappoint.    

Current Price: $16.79
Downside Target: $11-$12 in 3-6 months
Trade: Buy AEO February 2011 Puts 

    

Retail Stock to Short – Sears (SHLD)

Sears Holdings Corporation (NASDAQ: SHLD) became a cult stock when billionaire hedge fund manager Eddie Lambert decided he’d try his hand at running a retail outlet, and combined the department store with discount retailer Kmart in 2005.    

The recession hasn’t helped matters, but it’s safe to say that this was a failed experiment. The company  just reported a big loss for the third quarter and has been steadily losing market share. Seriously, when was the last time you shopped at Sears? Unless perhaps you’re one of a dying breed of customers who still has a Sears charge card. And while Kmart has seen bit of a resurgence lately, let’s face it, we live in a Wal-Mart world.    

The stock is already trading at about half of its 52-week high, but I expect this shabby retailer to have disappointing holiday season, and those struggles should continue into the new year.    

Current Price: $66.27
Downside Target: $50 in 12 months
Trade: Buy SHLD January 2012 Puts    

     

Retail Stock to Short – HHGregg (HGG)

Specialty retailer HHGregg, Inc. (NYSE: HGG) sells home appliances and consumer electronics — everything from MP3 players to dishwashers to flat panel TVs. The company also provides delivery, installation, and in-home repair and maintenance.    

HHGregg is a nice store with very good sales people, but sometimes nice guys finish last. I just don’t think HGG can stand up to the competition. Flat panel TV prices are falling fast due to weak demand and competition from Costco Wholesale Corporation (NASDAQ: COST) and Amazon.com, Inc. (NASDAQ: AMZN). And HHG is much more dependent on home electronics for sales and margins than Best Buy Co., Inc. (NYSE: BBY), its primary competitor, which has far superior computer, movie and music offerings.    

Current Price: $24.95
Downside Target: $16-$18 in 6-9 months
Trade: Buy HGG April 2011 Puts    

     

Retail Stock to Short – Home Depot (HD)

One segment of the retail sector that I think will really struggle in the year ahead is home improvement stores. The Home Depot, Inc. (NYSE: HD) did just report better-than-expected Q3 earnings, but don’t start thinking it’s smooth sailing from here on out. The company also said sales will miss the previous growth forecast.    

The housing sector is far from recovering. In fact, home prices dropped in October. I think HD is a better short candidate than competitor Lowe’s Companies, Inc. (NYSE: LOW), because much of its revenue is exposed to big home remodeling projects.    

Current Price: $31.12
Downside Target: $24 in 6-9 months
Trade: Buy HD May 2011 Puts