Retail stocks have been a tough trade in 2019. While the S&P 500 is up nearly 20% year-to-date, the SPDR S&P Retail ETF (NYSEARCA:XRT) is up just 3%, as retail stocks have been weighed by sluggish consumer spending in early 2019 and overarching trade conflicts. The sum of those headwinds has weighed on revenues and margins, and profit growth rates in the consumer discretionary sector actually dropped into negative territory in the first quarter of 2019, while S&P 500 earnings rose 4%.
But, Goldman Sachs thinks things are about to get a whole lot better for a whole lot of retail stocks.
Goldman Sachs believes that: 1) the macro consumer economic environment is improving, supported by low unemployment and strong wage gains, and that such improvement will re-accelerate retail revenue growth rates; 2) trade issues are being overblown in the near term and have a chance to cool off in the medium to long term; and 3) after years of investing into their e-commerce operations, big box retailers are ready to reap the operating income growth rewards of those investments.
Owing to these three core beliefs, Goldman Sachs has a Buy rating on several retail stocks. Which stocks made the cut? And will those stocks actually outperform from here? Let’s take a closer look at nine retail stocks that Goldman thinks are ready to rally.
The Bull Thesis: Goldman’s top pick is Target (NYSE:TGT), and the thesis here is pretty straight-forward. Target has invested big into its e-commerce and omni-channel business over the past few years. Now, the company’s e-commerce business is the fastest growing online retail business among big name retailers, and Target’s comparable sales growth has also been among the best in the business over the past few quarters. Thus, these investments are paying off in the form of supercharged top-line growth. Over the next few quarters, the cost base from these investments will start to moderate, too, and supercharged revenue growth will be accompanied by supercharged profit growth. That profit growth will converge on a reasonable valuation (14-times forward earnings) to spark a nice rally in TGT stock.
Does It Hold Water? Yes. TGT stock is one of my favorite retail stocks for the foreseeable future, too, because this company is firing on all cylinders, continues to be relentlessly innovative, has big profit growth potential in the medium term, and continues to trade at a relatively discounted valuation. That combination ultimately implies that Target stock has runway to move higher over the next few quarters.
The Bull Thesis: Another big box retailer that Goldman is bullish on is Costco (NASDAQ:COST). Much like Target, the bull thesis on COST stock is pretty straightforward, too. With Costco, you have the offline version of Amazon (NASDAQ:AMZN), which has leveraged low price appeal to create a huge base of loyal Costco members that shop at Costco often and in heavy volume. That loyal membership base will continue to power healthy results for the retailer for the foreseeable future, so long as consumer economic conditions remain favorable. If they do, those healthy results will in turn continue to drive COST stock higher.
Does It Hold Water? Yes. But, with one important catch: valuation. Unlike other retail stocks on this list, COST stock isn’t dirt cheap. Instead, it’s the opposite of dirt cheap. It’s an expensive stock, at 34-times forward earnings for what projects as a 10% profit grower over the next several years. That isn’t a terribly attractive combination, so in the the near term, valuation friction may limit further gains in COST stock.
The Bull Thesis: Goldman is also bullish on the 800 pound gorilla in the retail world: Walmart (NYSE:WMT). The Walmart thesis is very similar to the Target thesis. Walmart has aggressively reinvented itself over the past several years as an omni-channel retailer with a red-hot e-commerce business, enhanced in-store presentations and multiple omni-channel capabilities like “buy online, pick up in store”. This reinvention has powered decade-best comparable sales and traffic growth at Walmart over the past few quarters. But, this reinvention has also been expensive, and weighed on margins. Going forward, the cost base from these investments should moderate, and robust profit growth should come back into the picture. As it does, WMT stock should trend higher.
Does It Hold Water? Yes. Much like TGT stock, WMT stock will head higher over the next few quarters as robust revenue growth and margin improvement will converge on a still reasonable valuation (23-times forward earnings) to drive share price out-performance.
Home Depot (HD)
The Bull Thesis: In the home improvement space, Goldman is bullish on shares of Home Depot (NYSE:HD). Home improvement market fundamentals are favorable, driven by low rates, low unemployment, strong wage gains and good credit. Home Depot is the leader in this market, and has been for some time. As such, as home improvement spend increases over the next few quarters, Home Depot’s growth rates should move higher. As those growth rates move higher, HD stock should trend higher, too.
Does It Hold Water? Yes. The valuation supporting HD stock remains reasonable, as the stock trades at just 21-times forward earnings for what projects as roughly 10% profit growth over the next several years. That favorable valuation, coupled with favorable market fundamentals and continued strong numbers, will keep HD stock on a healthy uptrend for the foreseeable future.
The Bull Thesis: Goldman likes home improvement retailer Lowe’s (NYSE:LOW), too, for the same reasons they like Home Depot. The home improvement market is supported by strong fundamentals at the current moment. Over the next few quarters, those strong fundamentals should drive higher home improvement spend. Some of that spend will land at Home Depot. Some of it will land at Lowe’s. As such, Lowe’s growth trend should improve into the back half of 2019. As it does, LOW stock should move higher.
Does It Hold Water? Yes. LOW stock was unfairly beaten up in May on margin concerns in its Q1 earnings report. But, those margin headwinds are ephemeral, and should ease going forward. As they do, that easing will couple with strong top-line momentum (Lowe’s also reported its best comp in recent memory last quarter) to produce robust profit growth. Simultaneously, LOW stock trades at a discount relative to HD stock (19-times forward earnings for LOW, versus 21-times for HD). This relative discount plus strong profit growth should equal big returns for LOW stock in the back half of 2019.
The Bull Thesis: In the smaller cap retail world, Goldman is bullish on BJ’s (NYSE:BJ). The bull thesis on BJ stock rests on two things. First, the macro consumer economic environment is improving, and supports strong consumer spend in the back half of 2019. Second, BJ’s is a wholesale club retailer, and the club model of leveraging low price appeal to create a loyal membership base (from which you generate substantial revenue) is a winning model — see Amazon and Costco. Thus, BJ’s has a winning strategy in a market gaining momentum, and that implies healthy growth potential for BJ stock going forward.
Does It Hold Water? Yes. BJ’s is basically like a mini-Costco with an East Coast focus and very low prices, meaning that this warehouse retailer has cut out a sustainable niche for itself in the discounted retail segment. Further, BJ stock trades at just 15-times forward earnings (versus a 34-times forward multiple for COST), so there’s substantial room for multiple expansion here in the event that BJ’s continues to report healthy numbers (which it should).
O’Reilly Automotive (ORLY)
The Bull Thesis: Goldman also has a buy rating on O’Reilly Automotive (NYSE:ORLY). O’Reilly Automotive is an auto parts retailer which has grown revenues at a fairly steady mid-single-digit rate for the past several years, during which the auto parts market in the U.S. has grown at a low-single-digit rate. Because of this track record of above-market growth, Goldman likes ORLY stock in the back half of 2019, when the auto parts segment should benefit from increased demand as rates drop and the auto market rebounds.
Does It Hold Water? Yes. So long as the U.S. consumer economy remains healthy and stable (as it projects to for the foreseeable future), then you can count on O’Reilly to deliver stable mid-single-digit revenue growth alongside gradual margin expansion. That combination on top of a 22-times forward multiple should produce healthy returns in ORLY stock going forward, especially with depressed interest rates broadly inflating equity valuations.
Tractor Supply (TSCO)
The Bull Thesis: Back to the home improvement world, Goldman also likes home improvement and agricultural goods retailer Tractor Supply (NASDAQ:TSCO). The bull thesis on TSCO is simple. Macro conditions in the home improvement and agriculture markets are favorable, and Tractor Supply’s retail locations are largely rural and insulated from being disrupted by the big-box same-day-delivery push. This insulation coupled with favorable market conditions should drive sustained healthy profit growth over the next few years, and keep TSCO stock on a winning path.
Does It Hold Water? Yes. The valuation on TSCO stock, while not cheap, is certainly reasonable, at 23-times forward earnings for what projects as double-digit profit growth (comprised of mid-single-digit revenue growth and gradual margin expansion). So long as interest rates remain low, this combination of a ~20 forward multiple and ~10% profit growth should work for TSCO stock.
The Bull Thesis: Tariff concerns have been a huge headache for Williams-Sonoma (NYSE:WSM), but Goldman thinks that the kitchenware and home furnishings retailer is ready to bounce back. Trade tensions are cooling, and with a truce on new tariffs between the two countries, it seems the worst of the trade war damage has already been inflicted. Going forward, the numbers here should get better, especially as buying conditions in the U.S. improve, too. This improvement should drive a nice rebound in WSM stock.
Does It Hold Water? Yes. Of all the retail stocks on this list, WSM is among one of the cheapest, at just 13-times forward earnings. To be sure, that’s because revenue growth and profit growth are relatively muted here (WSM projects as a mid single-digit profit grower). But, that growth trajectory could inflect higher as trade issues become old news. In the event that happens, sentiment will improve, and WSM stock will benefit from substantial multiple expansion.
As of this writing, Luke Lango was long TGT, AMZN, WMT, HD and LOW.