The stock market is having its best year since 1997. Retail stocks, though, didn’t get an invite to the party. Year-to-date, the S&P 500 is up a whopping 18%. As for retail stocks, the SPDR S&P Retail ETF (NYSEARCA:XRT) is up a meager 3%.
Let’s put this in context. The unemployment rate in the U.S. is at record lows. Wage growth is running at decade highs. Consumer confidence and sentiment have surged higher in 2019. Rates have dropped. Credit is good. Households aren’t overly leveraged. Everything is going right for the U.S. consumer.
Yet, despite everything going right, retail stocks are still up just 3% year-to-date, versus an 18% gain for the S&P 500. Why? The trade war, and a sluggish consumer in early 2019.
But, the U.S.-China trade war has been put on hold. It looks increasingly likely that a deal will be struck soon. At the same time, the Fed projects to cut rates this summer, and that should goose the economy and reinvigorate the consumer.
Thus, the two headwinds that have killed retail stocks year-to-date, could reverse course this summer, and turn into tailwinds by the end of the year. That reversal ultimately means that retail stocks have big upside potential over the next several months from today’s depressed levels.
Which retail stocks should you buy to play this retail recovery rally? Let’s take a look.
Foot Locker (FL)
Athletic footwear retailer Foot Locker (NYSE:FL) has had a tough time over the past few years. The athletic retail market has shifted from wholesale retail to direct retail, and that shift has meant lower sales volume through wholesale retail distributors like Foot Locker. But, this shift has normalized over the past few quarters. As it has, Foot Locker’s numbers have improved, and the stock has moved higher.
The trade war knocked this FL recovery off course in 2019. Foot Locker is at the epicenter of the trade war, since the athletic footwear industry outsources a lot of production to China. As such, higher tariffs on China imports stand to significantly and adversely impact Foot Locker’s numbers. Investors have been persistently nervous about this, and FL stock has dropped as trade tensions have hung around.
Those trade tensions are now de-escalating. A deal looks likely soon. At the same time, the Fed is going to cut rates, and that will reinvigorate a sluggish consumer. The financial implications for Foot Locker? Stronger comparable sales growth and higher margins. That combination should ultimately spark a big rally in FL stock, which presently trades at an anemic 8-times forward earnings multiple.
Much like Foot Locker, mall retail giant Macy’s (NYSE:M) has had a tough time over the past several years as the retail world has shifted from wholesale to direct. This shift has pushed consumers to direct-focused retail platforms like Amazon (NASDAQ:AMZN). Macy’s has had trouble keeping up. Sales, margin and profit trends have been weak. Macy’s stock has also been weak.
Adverse secular trends coupled with trade war headwinds have pushed Macy’s stock to depressed levels in 2019. We are talking 7-times forward earnings and a 7%-plus dividend yield. In other words, the sentiment is so negative surrounding Macy’s stock that the stock is now essentially priced for profit trends to remain weak forever.
That won’t happen. A trade deal and rate cuts will provide a big tailwind to the retail industry in the back half of 2019. This rising tide will lift all boats, even the beaten-up ones like Macy’s. As such, Macy’s profit trends will improve throughout the course of 2019, and as they do, Macy’s stock should rally in a big way given its presently depressed valuation.
Unlike Foot Locker and Macy’s, sandal footwear brand Crocs (NASDAQ:CROX) has actually experienced tremendous success over the past few years. The brand orchestrated a huge operational turnaround in the mid-2010’s through narrowing the product portfolio and focusing on the company’s classic foam clog. Doing so reinvigorated revenue growth and cut expenses from the operating model, which produced robust profit growth. That robust profit growth propelled CROX stock from $6 in mid-2017, to over $30 by early 2019.
The CROX turnaround hit a road-bump in early 2019. First quarter numbers weren’t good. Sales growth slowed and gross margins tightened. The outlook wasn’t great, either. Broadly, Crocs reported early 2019 numbers that implied that the best of the CROX turnaround is over. Investors proceeded to dump CROX stock. The stock now trades 35% off its 2019 highs.
But, since those ugly early 2019 numbers, U.S. labor markets have remained healthy, rates have plunged, and trade tensions have eased. Plus, consumer interest with respect to Crocs has only surged higher since then, and the company just scored a big partnership with Vera Bradley.
In other words, recent data implies that the best of the CROX turnaround is not over, the company the will report strong second-quarter numbers soon, and CROX stock is due for a nice recovery rally.
Similar to Macy’s, mall retail giant Nordstrom (NYSE:JWN) has struggled over the past several years to drive traffic gains against the backdrop of a consumer exodus from physical to digital shopping channels. These struggles got really bad in early 2019. The company recently reported awful first-quarter numbers that included negative comparable sales growth and margin compression. Management also cut the full year 2019 guide. In response, JWN stock tumbled.
But, really bad early 2019 numbers were an anomaly produced by ephemeral headwinds, such as poor execution on a new loyalty program and a lack of digital marketing spend. Those two hiccups have been remedied. As such, it is likely that Nordstrom’s numbers improve meaningfully into the summer, especially with trade tensions cooling, the labor market healthy and a rate cut on the way.
Improving numbers should spark a rally in JWN stock. The stock trades 50% off recent highs. It’s also at a decade-low valuation level. This combination of fundamental improvements and a depressed valuation give the stock ample firepower to shoot higher over the next few months.
Canada Goose (GOOS)
Luxury outdoor apparel brand Canada Goose (NYSE:GOOS) was once one of Wall Street’s favorite retail stocks, due to its robust growth trajectory. Then, the company reported sub-par fourth-quarter numbers that comprised of slowing growth trends and delivered a disappointing long-term growth guide. The implication? The growth trajectory here isn’t as robust as everyone thought it was. GOOS stock subsequently dropped.
But, Canada Goose is still a 20%-plus revenue growth company with a healthy and expanding margin profile. Net net, that should drive 20%-plus profit growth, versus an average long-term profit growth rate across the retail segment of below 10%. For that sub-10% growth, retail stocks are trading at 18-times forward earnings. For more than double that growth potential (20%-plus profit growth), GOOS stock is trading at less than double the retail average valuation (30-times forward earnings).
Thus, relative to other retail stocks, GOOS stock now gives investors more bang for their buck. As such, as the broader retail industry rallies over the next several months thanks to cooling trade tensions and rate cuts, GOOS stock should generate alpha relative to its peers due to its attractive fundamentals and favorable valuation.
Dollar General (DG)
You want to buy off-price retail giant Dollar General (NYSE:DG) because this company has found a winning strategy in the dynamic retail landscape, and it will continue to leverage that winning strategy to drive high-quality profit growth over the next several years.
Over the past decade, Dollar General has honed in on becoming a go-to off price destination for consumer staples products. Because consumers always need to buy consumer staples products, and because consumers always love low prices, this retailing strategy has produced strong sales and profit growth for Dollar General over the past several years.
This strong growth continued in early 2019, when the rest of retail broadly reported bad numbers. It’s also expected to persist for the rest of the year, as management delivered a healthy full-year 2019 guide in the company’s last earnings report. The implication? Dollar General will continue to leverage its winning off-price retailing strategy to drive big profit growth for the next several quarters and years, regardless of how the rest of the retail shapes up.
So long as the profit growth trend here remains favorable, DG stock should continue to move higher. As such, the smart move here is to stick with the rally in DG stock for the foreseeable future.
The bull thesis on Lowe’s (NYSE:LOW) is pretty simple. For all intents and purposes, Home Depot (NYSE:HD) and Lowe’s are largely the same company, so their stocks should trade at similar valuations. Normally, they do. But, every once in a while, LOW stock trades at a sizable discount to HD stock. Whenever this valuation discrepancy arises, it’s usually a signal to buy LOW stock (so long as the economic backdrop remains favorable).
That’s exactly where we are today. HD stock trades north of 20-times forward earnings. LOW stock trades at just 18-times forward earnings. That’s the biggest valuation discrepancy between these two stocks over the past three years. Meanwhile, the economic backdrop is favorable (low rates, full labor market, big wage gains, etc.), and Lowe’s actually just out-comped Home Depot last quarter.
Net net, LOW stock presently trades at a sizable discount to HD stock, but the fundamentals say it shouldn’t. Ultimately, the fundamentals will win out here, meaning LOW stock is due for a nice rally over the next few months.
As of this writing, Luke Lango was long FL, M, AMZn, CROX, JWN and LOW.