The economy of the United States is largely consumption-driven. Within consumption expenditure, retail sale is an important component and a key economic driver. Factors such as inflation, rising interest rates, and economic concerns, have impacted retail sales growth. However, these same problems have led to the rise of retail stocks.
This, in turn, has negatively impacted sentiments for retail stocks. Of course, there are exceptions like Costco Wholesale (NASDAQ:COST) with the company continuing to deliver robust numbers. However, COST stock trades at a premium valuation.
Coming back to the industry, it’s worth noting that U.S. retail sales increased by 0.7% in July, which was higher than estimated. With inflation moderating and the holiday season approaching, there is a case for investment in undervalued retail stocks.
In my view, the retail stocks discussed can deliver 30% to 50% of total returns in the next 24 months. This would imply annualized returns that comfortably beat index returns. This column discusses the fundamental reasons to be bullish.
Target Corporation (TGT)
After a correction of almost 30% in the last 12 months, Target Corporation (NYSE:TGT) stock looks attractive. A forward price-earnings ratio of 16.1 indicates a valuation gap and TGT stock offers a dividend yield of 3.59%.
An important point to note is that Target has faced growth headwinds. For Q2 2023, the company’s comparable store sales declined by 5.4% on a year-on-year basis. However, amidst the gloom, there are a few positives to note.
First, for Q2 2023, Target reported a gross margin of 27%, which was higher by 550 basis points on a year-on-year basis. As inflationary pressure declines on a relative basis, margin improvement is likely to be sustained.
Further, with the holiday season approaching, it’s likely that the results for the second half will be encouraging. This is a potential catalyst for TGT stock to trend higher from undervalued levels.
I must add that Target announced an investment target of $4 to $5 billion for 2023 to fuel growth. The investment targets differentiated guest experience, new stores, store remodeling, and expanding its own brand portfolio. These investments are likely to deliver positive results.
The Home Depot (HD)
The Home Depot (NYSE:HD) is another attractive name among undervalued retail stocks to buy and hold. HD stock has remained almost sideways for year-to-date and a breakout on the upside is imminent for this 2.55% dividend yield name.
For 2023, Home Depot has a subdued outlook with sales and comparable sales likely to decline by 2% and 5% respectively. An important point to note is that even with subdued sales, the company has reported $12 billion in operating cash flow for the first half of 2023.
This provides high flexibility for capital investments, share repurchases, and dividends. In August, the company authorized a $15 billion share repurchase program.
Coming back to the business, Home Depot believes that it can increase market share “in a large and fragmented market.” Given the flexibility to make big investments, the long-term growth outlook is robust and HD stock looks attractive during this period of consolidation. A forward price-earnings ratio of 21.4 underscores my view from a valuation perspective.
Best Buy (BBY)
Best Buy (NYSE:BBY) is another undervalued retail stock that’s worth accumulating. In the last 12 months, BBY stock has remained sideways and trades at an attractive forward price-earnings ratio of 11.7. Further, the stock offers a dividend yield of 5.5%. I believe that BBY stock can potentially deliver total returns of 30% to 40% in the next 24 months.
Best Buy has reported subdued numbers and for Q2, the company’s comparable sales declined by 6.2%. The company believes that comparable sales will decline by 3% to 6% for the financial year 2024.
However, the reason to be bullish is as follows. The company expects that 2023 will be the “low point in tech demand after two years of sales declines.” It’s likely that growth will come next year driven by “the natural upgrade and replacement cycles.” Therefore, the worst might be over in terms of margin compression and sales decline. Given the valuation, there seems to be scope for a meaningful rally as the comparable store sales trend reverses.
On the date of publication, Faisal Humayun did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.