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It may not be a stellar holiday season for retail sales, but investors can still find retailing stocks to put in their stockings. Chief among them are discount stores and shops specializing in items that cater to what Maureen Carini, Standard & Poor's investment officer, brands consumers' "cocooning trend."
Karen Sack, S&P senior industry analyst, and Carini agree on their holiday forecast. Clouding the foggy outlook further is the abnormally mild weather, which has hurt sales of big-ticket winter wear. Because of the economy's impact on upscale goods, discount stores look better than department stores such as Saks and Neiman-Marcus. As a result, Wal-Mart and Family Dollar Stores, for instance, both carry S&P's accumulate ratings.
Among the S&P buys in retailing are Home Depot and Williams-Sonoma, and on the accumulate level, Lands' End gets high marks both for its catalog sales and the success of its Web site. At the other end of the spectrum, the Gap carries an avoid ranking, partly because of "fashion missteps."
S&P's Sack and Carini made these comments in a chat presented Dec. 4 by BusinessWeek Online and Standard & Poor's on America Online. They were replying to questions from the audience and from Jack Dierdorff of BW Online. Edited excerpts from this chat follow. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.
A: How [fares] retailing generally, with consumer spending so crucial to our economy?
Karen: The Christmas outlook is not good for consumer spending. That's for obvious reasons -- we're in a recession, there are job layoffs. Looking beyond that, we're looking at an economic recovery in the second quarter of 2002. We think that consumer spending will begin to pick up at that time.
Maureen: I agree with Karen that holiday spending is expected to be weak. This is being exacerbated by the springlike temperatures over the past couple of weeks, which is hurting demand for sweaters and other winter wear. Those are generally big-ticket items at this time of the year.
Q: Christmas is so important in retail, and if it's down this year, how much will that hurt your stocks?
Maureen: For apparel retailers, much of their sales are done during the holiday season. This year, if sales are weak as expected, we will once again see heavy discounting. That will continue to hurt margins and affect earnings.
Karen: From a different perspective, fourth-quarter earnings, which include the Christmas holiday, can be between 40% and 60% of total annual earnings. Having said that, the stock market usually looks ahead about six months. So much of the weak Christmas outlook has already been factored into many of these stocks.
Q: Any hope for Dollar General (DG
Karen: We're neutral on Dollar General at this point. There's a cloud over the company since they announced that they had to restate their earnings [going] back three years -- to 1998 -- because of accounting problems. Because of that, they haven't reported their earnings for this year. Until that cloud is removed from the company, we're going to stay on the sidelines.
Q: Kohl's Stores (KSS
) -- is it a good buy or overpriced?
Karen: Kohl's stock has done very well, with the company growing rapidly and gaining market share. But since it has had a big price runup, we would wait to see if there were any declines in the stock before we might look to recommend it. It appears fairly valued at this point in time.
Q: An opinion on Walgreen (WAG
) for the next 12 months?
Maureen: We carry a hold opinion on the shares. Although the pharmacy business is resisting the trends of the other retailers by posting same-store sales up 17% (nonpharmacy same-store sales were up just 1%), we expect gross margins to continue to be pressured by increased third-party business, price cuts, and a lower margin mix.
Q: How about Costco (COST
Karen: Costco and many of the other discount stores have outperformed other sectors in retailing. We have a hold recommendation on the stock, or 3-STARS. We feel that it's fairly valued at this point in time. There are other discount stores that I follow, Wal-Mart (WMT
) and Family Dollar (FDO
), for instance. Wal-Mart is outperforming the rest of the discount-store sector, continuing to roll back prices and gain market share. Family Dollar also has been posting strong sales, and earnings should advance about 18% annually for the next few years. Both of those stocks -- Wal-Mart and Family Dollar -- are 4-STARS (accumulate) [in S&P's Stock Appreciation Ranking System].
Q: Which has better long-term potential -- Target (TGT
) or Home Depot (HD
Karen: We have a hold on Target because the retail environment has been so highly competitive. They've been hurt by Marshall Field's [a unit of Target] -- the weak apparel sales have hurt the profitability of Marshall Field's. Over the longer term, their Target upscale discount stores will propel earnings growth.
Maureen: We recommend HD as a buy right now. Industrywide, we believe that low interest rates should aid sales growth. Home Depot has been slowing its expansion strategy going forward to focus on store productivity. They're also expanding their efforts to more contractors and offering more value-added services and products. That should boost margins. We expect earnings to grow about 18% to 20% annually for the next three years.
Q: Is HD or Lowe's (LOW
) better long term, or is it a coin flip?
Maureen: Right now, I'd recommend HD over LOW. I do have a 4-STAR recommendation on Lowe's as well, however. They both will benefit from positive industry trends. But Home Depot's stores are more productive, their sales per square foot are better, their return on equity is better, and their size gives them more clout in entering new markets and grabbing more market share (see BW Online, 12/05/01, "How Home Depot and Lowe's Measure Up").
Q: Given the mediocre near-term prospects for sales, what type of retailer looks best to you now? Any buys in your coverage area, besides HD?
Maureen: The retailers that look best now are the ones that show the ability to quickly adapt to changing sales trends by controlling inventory levels and operating costs. Another recommendation I've got is Williams-Sonoma (WSM
), which has demonstrated that [ability] in recent quarters. It's a 5-STAR buy.
Q: Is Gap (GPS
) a buy now?
Maureen: I carry an avoid recommendation on Gap shares. The company continues to suffer from fashion missteps, weak same-store sales, heavy discounting, and a weakening economy. Even though the shares are down significantly this year, we believe that they're still overpriced and could suffer from further earnings shortfalls.
Q: One hears that some of the top-end retailers and purveyors of luxury goods are not doing well. Is that true for their stocks as well?
Karen: There are two upscale department-store chains, Saks (SKS
) and Neiman Marcus (NMG.A
), and that is the case. The upscale retailers have had declines in same-store sales that were dramatic. Profitability is down considerably from a year ago. The obvious reasons? The weakening economy, [and] the absence of the wealth effect from gains in the stock market from the late 1990s.
Q: Is Pier One (PIR
) a buy?
Maureen: Pier One is an accumulate. The store is benefiting from the consumer trend to stay at home rather than traveling. Following a dramatic drop in sales after the September 11 attacks, momentum has picked up, and same-store sales have accelerated since the end of September. The company recently revised its outlook for its third and fourth quarter, to reflect the strong sales. The company has also been focusing on remerchandising its stores. That has met great success with consumers. As a result, margins are improving because of less discounting.
Q: You've named several S&P 4-STARS (accumulate) -- any others in your area to add?
Karen: Let's talk about Lands' End (LE
). That company is also an accumulate. They came in with very strong third-quarter earnings -- better than expected. We believe that in spite of the unseasonably warm weather so far, they'll have very good Christmas sales. Earnings will be up strongly this year over last year.
Q: From an investment point of view, how is online shopping affecting the industry? Who's doing best with it?
Karen: That really reflects on Lands' End, and one of the reasons that I'm recommending the stock is that their Web site is a natural extension of their catalogue. They have a loyal consumer who receives the catalogue, then orders online. That has worked very well for the company. Their Web site is profitable.
Maureen: The model that's becoming more apparent is the bricks-and-clicks model. That model is the one where retail stores have Web sites, and consumers are able to shop a store that they're familiar with. The customers also have the ability to return items to the store that they may not want.
Q: So far, we haven't breathed a word about that retail giant -- Sears (S
). How are it and its stock doing?
Karen: Their appliance sales have been very strong. But the company overall has been losing market share to discount stores such as Wal-Mart. And Sears has a very high cost structure. The company is going to change its stores to make the departments that don't need customer service into centralized checkout areas. This will lower the cost structure and, hopefully over time, will make it more competitive and profitable. We do have an accumulate on the stock for that reason.
Q: 'Tis the season for toys -- any names there?
Karen: Most traditional games and toys should do well. That includes baby-boomer and Generation-X classics. Newer items that are also popular are Harry Potter and Monsters [Inc.], and hot new video-game consoles are already in short supply. Some stocks to watch -- some accumulates -- Hasbro (HAS
), Mattel (MAT
), and Toys 'R' Us (TOY
Maureen: Most toy retailers this year were conservative in their Christmas planning, which is leading to shortages in toys compared to past years. That should lead to less discounting after the season. In addition, many retailers now have exclusive licenses to certain lines of toys with the manufacturers. That eliminates price discounting against other retailers.
Q: What do you like best this holiday season, both in types of retailers and in specific stocks?
Maureen: In my universe, I'm partial this year to stocks that surround the home and support the consumer's cocooning trend. My favorites from that universe are: Home Depot and Williams-Sonoma (both are 5-STAR). I also recommend as 4-STAR candidates: Bed Bath & Beyond (BBBY
), Linens 'n Things (LIN
), and Pier 1.
Karen: I think that the trend of discount stores outperforming department stores will continue. In light of that, we have accumulates on Wal-Mart, Family Dollar, and Lands' End, the catalogue retailer. Lands' End's sales should continue to grow strongly.