Click to Enlarge It’s a sign of something bigger.
The halcyon days of retail stocks where seemingly every company hit new highs is over. While not every retailer is beaten down — Michael Kors (KORS) and Kate Spade (KATE) are both within 15% of five-year high — many are, including Aeropostale.
However, while retail stocks to buy are few and far between these days … they still exist. For instance, at the end of April, Briefing.com’s Patrick O’Hare put together a group of nine retailers that are beaten down but potentially make great stocks to buy, and I happen to strongly agree with a couple of the picks myself.
Those of you willing to accept a significant amount of risk should consider these three retail stocks to buy. Doing so, however, takes conviction. If you can’t stand the heat — please don’t go in the kitchen.
Retail Stocks to Buy – Ulta Salon (ULTA)
I was surprised to see Ulta Salon (ULTA) included in this group because its business is somewhat insulated from the problems facing most retail stocks at the moment. While it’s still growing — comparable-store sales in fiscal 2013 increased 7.9% year-over-year, with net sales up 20.3% — the clouds on the horizon are looking a little ominous.
Mary Dillon has been CEO for almost a year now, and the marketing veteran has come to the conclusion that Ulta can’t handle the pace of growth its five-year plan forecasts, which is to open 536 stores or more than 100 per year. Investors have balked at her more cautious expansion plan and dropped ULTA stock by 10% in the past month alone. Considering ULTA’s excellent previous performance, that has to be an eye-opener.
To make matters worse, Herb Greenberg is writing bad things about the company. Greenberg is relentless at staying close to stocks he feels are hiding the truth from investors. In the case of ULTA, Greenberg questions its use of uniform capitalization accounting, which allows it to capitalize everyday business expenses like buyers’ salaries into inventory, artificially boosting operating profits.
In the past two years, Ulta’s merchandise inventories have averaged an increase of $107 million compared to an average of $19 million in the two years before that. Greenberg believes an inventory write-down is coming sooner rather than later.
If you look at Ulta’s inventory at the end of fiscal 2009 you’ll see that it was $207 million. By the end of this past year, it had grown 121% to $458 million. At the same time, revenues grew 119% to $2.67 billion. There’s nothing unusual about these numbers, and while the pace of inventory growth over the past two years has sped up, it has come as a result of ULTA doubling the number of store openings.
If ULTA writes down inventory (a big if), I don’t imagine it would amount to more than a $90 million charge based on inventory growing at the same rate as sales. With lots of cash and no debt, I believe the uncertainty created by Dillon’s continuing transformation creates huge buying opportunities for ULTA stock. Of these three retail stocks to buy, ULTA is my favorite.
Retail Stocks to Buy – Tilly’s (TLYS)
Two years ago, surf-and-skate retailer Tilly’s (TLYS) came out of the gate fast, closing up 10% at $17.07 in its first day of trading. All things pointed to a prosperous future. Earnings and sales were growing and investors were willing to pay up — IPO shares projected between $11.50 and $13.50 per share but priced at $15.50 — for the privilege of owning its shares. It was considered one of the best small-cap retail stocks to buy.
That was then.
Now, TLYS is trading below $12, off more than 30% in the past year alone. Investors still holding their IPO shares have lost 28% of their original investment. Hindsight suggests underwriters got the pricing terribly wrong. You’d have been much better off buying an S&P 500 ETF.
The truth is IPOs often trade for less 12 to 24 months after going public. In my opinion, Tilly’s is setting up to be a very timely investment. Here’s why.
Little about Tilly’s Q4 results was very promising. Overall sales declined 0.6% year-over-year, same-store sales were off 4.9%, operating profits declined 30% in the quarter to $10.3 million and earnings per share dropped a whopping 68% to 19 cents. To make matters worse, its first-quarter outlook was awful, with comps down mid-single digits and little or no profit. It’s hardly the booming business investors were presented back in 2012.
Like I said, it’s all about timing.
Teen-based retailers have been crushed the past year, and Tilly’s is no different. Business is going to get worse before it gets better. The good news is that its e-commerce business now accounts for 12% of revenue and is still growing. In addition, TLYS has done a good job holding the line on expenses at a time when business clearly isn’t in its favor. With no debt, Tilly’s been able to fund store openings (18 in 2014) from operating cash, meaning it can continue to absorb the body blows of declining sales without completely sacrificing profitability.
While TLYS stock might continue to fall, I believe the bad news is already baked into its price. Any good news over the next two or three quarters along with continued economic improvement will have its stock back around its IPO price in no time.
Of these 10 retail stocks to buy it’s definitely a strong second place.
Retail Stocks to Buy – Aeropostale (ARO)
This is my wildcard pick, so I’m not going to say much except that CEO Tom Johnson is a seasoned retailer who’s capable of righting the ship. With ARO stock down 51% year-to-date and cash slowly disappearing, though, Johnson is running out of time.
Eventually, someone is going to come along and buy the company, and the longer this process takes, the less investors can hope to make from the deal.
ARO stock is trading for one-sixth the price it did in early 2010. Any bet at this point must be considered in the same vein as the money you take to the casino on Saturday night — expect to lose it and you won’t be disappointed when you do.
If you can’t look at it this way, you definitely should stay away from Aeropostale. Its comeback is anything but certain.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.