Retail Stocks Tumble — Time to Buy, or Bail?

by James Brumley | August 22, 2013 7:24 am

The past several days haven’t been especially kind to the market. The S&P 500 is off nearly 4% since its early August peak, and as of Wednesday’s action, it looks poised to enter a “from bad to worse” situation.

As rough as it has been for the broad market, though, it’s been significantly worse for one group in particular: retail stocks. Some of the industry’s biggest names — spanning from discounters like Walmart (WMT[1]) to upper-end names Macy’s (M[2]) — have taken on more than their fair share of water since the end of July. Walmart shares are off 6.6%, for instance, while Macy’s is down 10% from its early-July peak. JCPenney (JCP[3]) and Target (TGT[4]) have both been drubbed lately as well, fueled by disappointing results and/or disappointing outlooks.

Is the industry really in this much trouble, or are investors overreacting and ultimately setting up a buying opportunity in retail stocks?

Target’s Numbers a Microcosm … Mostly

Truth be told, though they’ve been hammered this month so far, retail stocks had at least a small shot at shrugging off this wave of weakness and getting back into a groove. That is, until Wednesday. That’s when Target — arguably one of the more reliable names in the retail bunch when it comes to predictable growth — posted its Q2 results and outlook.

The second-quarter numbers were actually pretty good. Target earned an operating profit of $1.19, up from last year’s $1.06. Sales were up 2% overall, and higher by 1.2% on a same-store-sales basis. Problem: The pros were looking for a bigger top line, and stronger same-store-sales growth.

It was the guidance that really kick-started the 4% plunge for TGT shares, however. The retailer now expects a per-share profit of only 80 to 90 cents in the third quarter, vs. previous analyst estimates of 89 cents, and for the full year, Target projects per-share profits to come in between $4.70 and $4.90, down from the previous outlook of $4.85 to $5.05 per share.

Target’s guidance put the exclamation point on a sizable slew of other red flags retail stocks began waving during the now-ending earnings season.

Walmart, of course, is the most-watched of those struggling stores. Though it met earnings estimates of $1.25 for the second quarter, following Q1’s miss, a mere “meet” wasn’t enough to stoke potential or current investors, especially when revenue was shy of forecasts. Walmart opined it was a combination of a tepid economy and higher payroll taxes that sapped business — a theory echoed by Target as well as a few others.

The problem might be bigger than the impact of slightly higher payroll tax rates, though, which should crimp lower-income consumers more so than high-end spenders. Ralph Lauren (RL[5]) and Coach (COH[6]) each reported poor numbers for last quarter. Coach’s revenue fell short of expectations, and Ralph Lauren’s same-store sales fell 1%. Both also reported fading foot traffic in its stores.

Macy’s numbers were similarly disappointing[7], but Macy’s might well have its consumer-understanding finger right on the pulse of the problem.

Macy’s chief financial officer Karen Hoguet said during the company’s most recent conference call, “We believe that much of our weakness is due to the health of the consumer and to the fact that consumers seem to be choosing to make purchases in non-department store categories such as cars, housing and home improvement.”

As it turns out, she was 100% right. As evidence to that end, Home Depot (HD[8]) and Lowe’s (LOW[9]) both knocked it out of the park in the second quarter[10]. Home Depot’s earnings grew 17% last quarter. Lowe’s pumped up its bottom line by 26%, and upped its full-year profit forecast from $2.05 to $2.10 per share, with revenue growth of 5% versus prior expectations of 4%.

Now What?

While the recent selling of most retail stocks might have been unnecessarily exaggerated, the broad concerns are merited. After all, many of the major retail names dialed back their current quarter and full-year estimates — a measure most of them would avoid taking if at all possible. There are pockets of strength, however, even if there’s little rhyme or reason for those hot spots.

Lowe’s and Home Depot clearly prove that home improvement is one of those pockets of strength, fueled by a steadily improving housing market. With both stocks near multiyear highs, though, that might not be the best spot for an investor to go shopping just yet.

So where should an investor go shop for a bargain? Incredibly enough — and despite the struggles experienced by Ralph Lauren and Coach last quarter — there are luxury names that are doing well. At the top of that list is Michael Kors (KORS[11]). In early August, the fashion brand name blew away first-quarter earnings estimates of 49 cents per share by posting a profit of 61 cents. Profits were up 82, revenue was up 54% and same-store sales grew 27%. Simply amazing.

So how did Kors do what Coach and Ralph Lauren couldn’t? All joking aside, Michael Kors is giving consumers exactly what they want[12] … a new, fresh label, and a new, fresh look. The Polo and Coach labels are starting to feel a little dated.

Point being, there are going to be retailers that survive, and even thrive in, what likely will be a tepid second half of 2013. They’re going to be the exception to the norm, however, so pick and choose carefully. They’ll have to be the outfits that offer consumers something they absolutely don’t want to live without. Kors is doing that. So is L Brands (LTD[13]) division Victoria’s Secret. Nobody “needs” anything either is selling, but they sure do want it.

Meanwhile, fewer and fewer people need or want what Target’s got to offer.

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

  1. WMT:
  2. M:
  3. JCP:
  4. TGT:
  5. RL:
  6. COH:
  7. Macy’s numbers were similarly disappointing:
  8. HD:
  9. LOW:
  10. both knocked it out of the park in the second quarter:
  11. KORS:
  12. Michael Kors is giving consumers exactly what they want:
  13. LTD:

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