Slowing Specialty Retailers?


By Sam Stovall There hasn't been much movement in the High Momentum List for a while, so I did some momentum fishing on my own. I found that Catalog Retail, Diversified Chemicals, Electronic Equipment Manufacturers, Movies and Entertainment, and Specialty Stores had shown upticks in their relative-strength rankings. I particularly liked the charts for Electronic Equipment Manufacturers and Specialty Stores.

But since our analysts' outlooks for both subindustry indexes are neutral, I selected Specialty Stores, because of the higher average STARS ranking.

VARIETY OF STORES. I asked Michael Souers, S&P's Specialty Retail analyst, if investors should buy into this rally. Souers has a neutral fundamental outlook for the specialty retail subindustry as most stocks remain fairly valued, in our opinion. Year to date through Aug. 12, the S&P Specialty Stores Index was up 10%, vs. a 2.2% increase in the S&P 1500 Index. In 2004, this subindustry index gained 7.2%, vs. a 10% increase for the S&P 1500.

This subindustry index is diverse, ranging from high-end jewelry stores to office-supply outfits. As a result, our outlook depends on the unique prospects of the individual companies and/or groups that constitute the subindustry.

Souers expects somewhat mixed results for specialty retailers for the second quarter as well as for the year. Auto-parts retailers have likely faced the adverse effects of relatively high gasoline prices in the first half of the year, but we expect strong yearly numbers from this group, with fairly easy comparisons in the latter half of the year. Office-supply retailers are likely to report moderate growth as capital spending by businesses remains fairly strong.

STILL BUILDING. We expect pet-supplies retailers to post strong quarterly and yearly earnings gains, bolstered by solid industry trends and a ramp-up in store growth. However, an expected slowdown in consumer spending has us somewhat cautious with regard to more "discretionary" stores such as arts and crafts.

For the longer term, Souers sees superstore growth slowing as other channels continue to make inroads. With increasing penetration of Internet services, including broadband, more U.S. households are shopping via the Internet in the comfort of their homes. Favored products for Internet shopping include computers, books, CDs, electronics, and toys.

Still, Souers does not foresee the demise of brick-and-mortar retailing. Most specialty retailers are continuing to build new stores, filling in existing markets, while penetrating new ones, including smaller markets with downsized stores. He thinks that companies with a strong brand name, aggressive brand support, and a mix of traditional stores and Web sites will likely be strong performers in the long run.

So there you have it. In S&P's view, the subindustry's momentum looks favorable, but the fundamentals don't support an aggressive stance in the coming year.

For the graph below, the jagged blue line represents the subindustry index's rolling 52-week price performance as compared with the 52-week performance for the S&P 1500. Any point above 100 indicates market outperformance over the prior year, while points below 100 indicate market underperformance. The red line is a rolling 39-week moving average, while the two green bands indicate one standard deviation above and below the subindustry index's 14-year mean relative strength.

 

Industry Momentum List Update

For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500) as of Aug. 12, 2005.

Industry

Computer & Electronics Retail

Construction Materials

Diversified Metals & Mining

Fertilizers & Agricultural Chemicals

Homebuilding

Managed Health Care

Marine

Oil & Gas Drilling

Oil & Gas Equipment & Services

Oil & Gas Exploration & Production

Oil & Gas Refining & Marketing

Water Utilities

Glossary

S&P STARS: Since January 1, 1987, Standard & Poor's Equity Research Services has ranked a universe of common stocks based on a given stock's potential for future performance. Under proprietary STARS (STock Appreciation Ranking System), S&P equity analysts rank stocks according to their individual forecast of a stock's future capital appreciation potential versus the expected performance of a relevant benchmark (e.g., a regional index (S&P Asia 50 Index, S&P Europe 350 Index or S&P 500 Index), based on a 12-month time horizon. STARS was designed to meet the needs of investors looking to put their investment decisions in perspective.

S&P Earnings & Dividend Rank (also known as S&P Quality Rank): Growth and stability of earnings and dividends are deemed key elements in establishing S&P's earnings and dividend rankings for common stocks, which are designed to capsulize the nature of this record in a single symbol. It should be noted, however, that the process also takes into consideration certain adjustments and modifications deemed desirable in establishing such rankings. The final score for each stock is measured against a scoring matrix determined by analysis of the scores of a large and representative sample of stocks. The range of scores in the array of this sample has been aligned with the following ladder of rankings:

A+

Highest

B

Lower

A

High

C

Lowest

A-

Above Average

D

In Reorganization

B+

Average

NR

Not Ranked

B-

Below Average

S&P Issuer Credit Rating: A Standard & Poor's Issuer Credit Rating is a current opinion of an obligor's overall financial capacity (its creditworthiness) to pay its financial obligations. This opinion focuses on the obligor's capacity and willingness to meet its financial commitments as they come due. It does not apply to any specific financial obligation, as it does not take into account the nature of and provisions of the obligation, its standing in bankruptcy or liquidation, statutory preferences, or the legality and enforceability of the obligation. In addition, it does not take into account the creditworthiness of the guarantors, insurers, or other forms of credit enhancement on the obligation. The Issuer Credit Rating is not a recommendation to purchase, sell, or hold a financial obligation issued by an obligor, as it does not comment on market price or suitability for a particular investor. Issuer Credit Ratings are based on current information furnished by obligors or obtained by Standard & Poor's from other sources it considers reliable. Standard & Poor's does not perform an audit in connection with any Issuer Credit Rating and may, on occasion, rely on unaudited financial information. Issuer Credit Ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information, or based on other circumstances.

S&P Core Earnings: Standard & Poor's Core Earnings is a uniform methodology for calculating operating earnings, and focuses on a company's after-tax earnings generated from its principal businesses. Included in the Standard & Poor's definition are employee stock option grant expenses, pension costs, restructuring charges from ongoing operations, write-downs of depreciable or amortizable operating assets, purchased research and development, M&A related expenses and unrealized gains/losses from hedging activities. Excluded from the definition are pension gains, impairment of goodwill charges, gains or losses from asset sales, reversal of prior-year charges and provision from litigation or insurance settlements.

S&P 12 Month Target Price: The S&P equity analyst's projection of the market price a given security will command 12 months hence, based on a combination of intrinsic, relative, and private market valuation metrics.

Standard & Poor's Equity Research Services: Standard & Poor's Equity Research Services U.S. includes Standard & Poor's Investment Advisory Services LLC; Standard & Poor's Equity Research Services Europe includes Standard & Poor's LLC- London and Standard & Poor's AB (Sweden); Standard & Poor's Equity Research Services Asia includes Standard & Poor's LLC's offices in Hong Kong, Singapore and Tokyo.

Required Disclosures

In the U.S.

As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 30.2% of issuers with buy recommendations, 57.5% with hold recommendations and 12.3% with sell recommendations.

In Europe

As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 34.4% of issuers with buy recommendations, 46.8% with hold recommendations and 18.8% with sell recommendations.

In Asia

As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 33.3% of issuers with buy recommendations, 47.2% with hold recommendations and 19.5% with sell recommendations.

Globally

As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 31.0% of issuers with buy recommendations, 55.4% with hold recommendations and 13.6% with sell recommendations.

5-STARS (Strong Buy): Total return is expected to outperform the total return of a relevant benchmark, by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.

4-STARS (Buy): Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis.

3-STARS (Hold): Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.

2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.

1-STARS (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.

Relevant benchmarks: in the U.S. the relevant benchmark is the S&P 500 Index, in Europe the S&P Europe 350 Index and in Asia the S&P Asia 50 Index.

For All Regions:

All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. Stovall is chief investment strategist for Standard & Poor's


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