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SECTOR SCOPE by James A. Anderson May 24, 1999

Blue-Light Specials among the Retailing Stocks
While most have have raced off on good economic news, you can still find some bargains in the group

If retailers ever imagine a Great Mall beyond the stars, their wildest dreams may not exceed the current business climate by much. A sure and steady U.S. economy over the past few years has provided the answer to almost every shop ownerís prayers -- and then some. The job market is strong, wages are rising, and inflation remains tame. Consumer confidence polls show most everyone to be in a cheery mood. And with the economy in for another decent growth spurt this year, itís little wonder that many Americans feel flush. Indeed, if the first-quarter results of companies such as Dayton Hudson (DH), Kmart (KM), and Wal-Mart (WMT) are any indication, shoppers are already treating themselves to a spree or two.

Revenue growth for the group was impressive for the first three months of the year and is likely to stay strong for the duration of 1999. According to the National Retail Federation (NRF), an industry trade group, general merchandise retailers saw a 9% jump in sales for the first quarter, vs. the same period in 1998, and can count on 7% sales growth for all of 1999. NRF Chief Economist Rosalind Wells says such increases are uncommonly strong, coming after gains of 6.8% and 5.3% in 1998 and 1997, respectively. Revenues for the industryís hottest sector, discount retailing, could leap as much as 15% this year over 1998, Wells adds.

That has been enough to set retail stocks on a nice run so far. A Standard & Poorís index of eight discounters is up 28.4% year to date, and general merchandise retailers such as Sears (S), Dayton Hudson, and Wal-Mart are up 11.2%, vs. 9.4% for the S&P 500.

OMINOUS WORDS. "Things donít get a hell of a lot better than they are now," says Michael B. Exstein, a retail industry analyst for Credit Suisse First Boston. "Weíre seeing that consumers feel good -- not only in the boost in comparable sales for the big chains, but by the fact that sales of higher-margin goods have been rising, too."

Those are ominous words on Wall Street, however, where even a hint that there's little room for improvement tends to pull the brakes on rallies. And now that stocks such as Wal-Mart fetch price-earnings multiples above 30, a number of analysts are turning their attention from the more expensive companies in the group to those that havenít yet joined the party. "Even though some members of the group are trading at p-es of 30 to 50 (compared with 28 for the S&P 500), itís probably wise to minimize your multiple risk starting in the second quarter," says Thomas H. Tashjian, retail analyst for Nationsbanc Montgomery Securities. The reason: Retail stocks tend to slumber in the second half of the year, especially if the Christmas shopping season falls even a hair short of expectations.

Ames Department Stores (AMES) is one play thatís reasonably priced, says Tashjian, who thinks the low-end discounter is in for a boost this year and next, when two scheduled increases in the minimum wage take effect. "That is sure to trigger above-average sales and earnings in the discount retail sector," says Tashjian. In March, Ames put the finishing touches on a merger with discount chain Hill Stores that boosted the companyís number of outlets to more than 450 from 300. That should help Ames realize an 80% jump in earnings next year, says Tashjian. And analysts predict that Ames' earnings will grow at a 18% average annual clip over the next five years, according to Zacks Investment Research.

SAKS ON SALE. The discounters' swanker cousins, department stores, may also be ripe for a move. An S&P index for the group is up just 5.2% for '99. Saks (SKS), seems poised to take off, for example. Formed last year when retail giant Proffitts snatched up Saks and kept the New York retailerís name, the upscale retailer should realize substantial efficiencies as it consolidates into a 334-store network. Saks's shares look as if they're on sale, trading at just under 14 times consensus analyst estimates according to Zacks. A dozen of the 14 analysts who cover the stock rate it a strong buy or buy, and they expect its earnings to increase an average 20% annually over the next five years. "Management under Brad Martin has a very strong reputation, and the Street has liked what theyíve done so far," says Loomis Sayles portfolio manager Dawn Alston Paige, who thinks Saks can reach $45 a share over the next 12 to 18 months.

Credit Suisseís Exstein calls Federated Department Storesí (FD) recent acquisition of Fingerhut, the nationís second-largest direct marketer, "an astute move that puts the company at the back end of E-commerce." Federated looks reasonably priced, too. The retailerís shares trade at 16 times estimated 1999 earnings. On the Street, where 13 of the 19 analysts who follow Federated rate the company a strong buy or buy, analysts look for it to deliver average annual earnings growth of 14% over the next five years.

If youíre looking for a mutual fund that covers the sector, try the Fidelity Select Retailing Fund (FSRPX). As of May 20, the fund had posted a total return for this year of 3.27%, according to Morningstar. Over the past three years, the Fidelity fund has averaged an annual total return of 27.22%.

James Anderson, who teaches journalism for the City University of New York, writes Sector Scope every other week

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