Analyst: Steer Clear of Most Retail Stocks

by Alyssa Oursler | August 12, 2013 9:44 am

So far in 2013, retail stocks have faced headwind after headwind. First it was the payroll tax. Then it was the sequester. And we can’t forget the weather[1].

Despite that reality, countless stocks have continued to march higher. In fact, the Market Vectors Retail ETF (RTH[2]) and Retail SPDR (XRT[3]) are outpacing the market with gains of 25% and 30% year-to-date, respectively.

Of course, such a big climb also could mean there’s just more room for a reversal.

Janney Montgomery Scott analyst Adrienne Tennant seems to think just that. Tennant anticipates a weak fall season and has downgraded the sector from “Neutralweight” to “Underweight” as a result.

A few of her main concerns include:

Her firm’s research focuses greatly on that last bullet, and actually breaks out the changes in promotional levels[4] — based on the first week in August — for each of the retailers it covers.

American Eagle (AEO[5]), for example, was one of the names the report cited as offering deeper discounts in the start of the third quarter — a trend that seems to have continued from the summer season.

Remember, AEO cut its Q2 EPS forecast[6] roughly in half last week in the face of weak sales and — yup, you guessed it — margins. The company dropped its expectations from a range of 19 to 21 cents to just 10 cents per share, and management said same-store sales slid an ugly 7% in the most recent period.

Analysts also have shaved 50 cents off the full-year forecast they had 90 days ago — a drop making up nearly one-third of the original estimate. No wonder, then, the stock has lost nearly 16% in the past five trading days.

AEO reports its Q2 numbers on Aug. 21. While there’s a chance that the biggest damage from deeper promotions and weak sales in the second quarter might already be done, there’s little reason to think the current back-to-school quarter[7] will get any better.

Other names with deeper discounts include Chico’s (CHS[8]) and Zumiez (ZUMZ[9]). Meanwhile, promotions at Aeropostale (ARO[10]) Abercrombie & Fitch (ANF[11]), Buckle (BKE[12]) and Francesca’s (FRAN[13]) were all roughly flat year-over-year.

Even Gap (GPS[14]), which has big gains and increasing earnings estimate in the books heading into its Q2 report[15], was offering slightly deeper promotions at its namesake locations, along with even deeper YOY sales at its Banana Republic locations.

The stock’s 40%-plus year-to-date gains could make investors ready to run at the slightest sign of weakness, too.

The lesson is simple: Be picky if you want to dabble in the retail sector. As second-quarter earnings — which included a weak July — are starting to trickle in, the third quarter already seems to be off to a slow start.

As of this writing, Alyssa Oursler did not hold a position in any of the aforementioned securities

  1. And we can’t forget the weather:
  2. RTH:
  3. XRT:
  4. breaks out the changes in promotional levels:
  5. AEO:
  6. cut its Q2 EPS forecast:
  7. current back-to-school quarter:
  8. CHS:
  9. ZUMZ:
  10. ARO:
  11. ANF:
  12. BKE:
  13. FRAN:
  14. GPS:
  15. heading into its Q2 report:

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