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More Markdowns for Retail Stocks?

Posted by: Ben Steverman on February 12, 2009

Ask a portfolio manager what stocks you should buy and there’s a very good chance he or she will warn you away from retail stocks. The consumer is scared and pinching pennies, they say, and unemployment is still on the rise. It’s going to be a long year for consumer discretionary stocks.

So then it’s a surprise when U.S. retail sales rise 1% in January, far more than economists were expecting. A few economists dismissed today’s number as the result of “seasonal distortions.” But, Mike Englund of Action Economics said it was good news, “a long-awaited sign of a diminishing consumer downdraft.” The report “puts a floor under the U.S. GDP contraction in the current quarter,” he wrote.

Is there hope for some consumer stocks after all?

Chipotle Mexican Grill (CMG) offered some hope today when the restaurant chain reported better-than-expected earnings and the stock surged 12%. Profit margins narrowed, but same-restaurant sales were up 3.5% and total revenue rose 20%. In 2009, the chain expects low-single-digit same-restaurant sales growth, and it plans to open 120 to 130 new restaurants.

Another company that might cheer investors is Costco Wholesale Corp. (COST). At least according to UBS (UBS) analyst Neil Currie, who recently upgraded the member warehouse chain from a ‘neutral’ rating to a ‘buy’ rating. While acknowledging the problems all retailers face, Currie pointed to Costco’s “record club traffic, rock solid membership, increasing relevance with shoppers and a strong balance sheet.”

This is, as Currie writes, an environment in which “consumers have largely pulled back on spending on anything that is not either food or heavily on sale.”

However, as demonstrated by today’s data, Chipotle’s sales figures and Costco’s traffic, it’s not at all true that consumers have stopped spending entirely. Dollars are flowing to stores and restaurants that are more “relevant” to these tough times.

Unfortunately, this argument only takes you so far. Companies relevant to cash-strapped consumers are already priced at a premium to other discretionary stocks. And nearly every retailer is trying to adjust to the new economic realities, resulting in a sector that is fiercely competitive and getting more so.

Currie’s report on Costco is titled “short-term pain for long-term gain.” But how much pain and for how long? That’s something no investor knows at this point.

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Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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