By gosh, by golly, the holiday retail outlook is jolly. Consumer sentiment recently reached its highest level since the turn of the century. The last time unemployment was this low was just after the first moon landing in 1969. Wages are rising at their fastest clip in nearly a decade. House prices will surely end the year higher. Even stocks, more naughty than nice since October, are hanging onto a modest gain for the year.
Backed by that swirl of good news, holiday sales are expected to increase 5% from a year ago, says brokerage firm Edward Jones. That's faster than the five-year average, and it comes atop 5.6% growth last year—the fastest since before the 2007-09 recession. Inventories look lean. There's even an added day versus last year between Thanksgiving and Christmas—prime shopping season.
Meanwhile, store chains have been learning lessons from Amazon.com's (AMZN) success, and investing in e-commerce fulfillment. "After years of retailers being on defense, now they're on offense," says Randal Konik, an analyst at Jefferies who covers apparel stores. "They've sped up their supply chains and in some cases improved delivery times from five to six days to two to three days."
All of that makes 2018, for retailers, a year of no excuses. For stores that struggle now, the problem is them, not the economy or Amazon. To find likely winners, stock investors should be cautious of malls, and of stores with a shortage of unique merchandise, while being bullish on those with digital savvy. Kohl's (KSS) and Target (TGT) appear poised to outperform. Home Depot (HD) and Tiffany (TIF) are worth their premium valuations. Best Buy (BBY) has had a heroic run, but now faces especially difficult sales comparisons versus last year. TJX (TJX) could cool, too. The outlook isn't promising for J.C. Penney (JCP) and L Brands (LB).
Kohl's offers an example of a retailer that is turning perceived weaknesses into strengths. By now, any big store chain that is taking e-commerce seriously has deployed infrastructure and software that allows orders to be fulfilled intelligently from either distribution centers or stores, and lets customers reserve items for pickup in stores.
At Kohl's, when customers place orders to ship single items—a margin-killer for retailers—its software can quickly determine the odds of the customer being lured by discount offers on add-on items. Customers who are unlikely to fill up their online carts might receive offers for, say, $5 in Kohl's Cash, part of the company's rewards program, to pick their items up at nearby stores. That cuts costs, drives traffic, and presents opportunities for more selling.
National brands like Nike (NKE) and UGG help drive traffic and provide Kohl's opportunities to sell private-label brands. The stores are mostly located in suburban strip malls, not enclosed malls, which helps insulate the company from the struggles of anchor tenants like Sears Holdings (SHLDQ), Macy's (M), and J.C. Penney. Kohl's has a robust mobile app and generous return policy, and in some markets is testing a partnership with Amazon to offer dropoff package returns and show-off smart-home devices like the Amazon Echo in its stores.
This fiscal year through January, Kohl's is expected to increase earnings per share by 31% to $5.49, on a 1.8% rise in same-store sales. Shares, which have returned 45% cumulatively over two years, still sell for less than 14 times this year's earnings estimate.
Cowen & Company analyst Oliver Chen calls Kohl's a top pick for the holidays, with a price target of $92 that implies more than 20% upside from recent levels. Beyond what he calls the company's "tactical creativity" he sees an opportunity for it to gain market share from the liquidation this year of regional department-store chain Bon-Ton, noting that 190 of its closed stores are within 10 miles of a Kohl's.
On Nov. 7, Chen also upgraded Target stock to Outperform from Market Perform and raised his price target by $10 to $100, versus a recent $81. Curbside pickup of orders, which has proved popular with customers, has been expanded to 1,000 stores from about 50 last year. Clerks can use hand-held devices to check shoppers out anywhere in stores.
Target has remodeled or expanded toy departments in hundreds of stores to capitalize on the bankruptcy of Toys "R" Us. It's offering free two-day shipping of orders during the holiday season, mirroring Amazon in what some analysts describe as a minimum requirement for mass merchants this year. Digital sales grew 35% during the first half of this fiscal year. For the full year, Wall Street predicts 15% earnings-per-share growth on a 4.9% rise in same-store sales.
Walmart (WMT) is also enjoying digital success, especially with click-and-collect orders for groceries, but Target has an edge with in-house design of proprietary goods to lure shoppers. It also might offer a better deal for investors. Walmart has generated a two-year, cumulative return of more than 50%, versus just 14% for Target. That has left Target selling at more than a 30% discount to Walmart based on forward price to earnings ratios, despite faster growth projections for Target. Over the past decade, on average, the two retailers have traded at similar valuations.
Jeweler Tiffany has a world-renowned brand but only a few hundred stores. That, combined with strong cash flow, is a recipe for future expansion. Under new management since last year, Tiffany has modernized designs across its home, accessories and fine jewelry categories, including the recently debuted Tiffany True, the company's first new engagement-ring design in nearly a decade. Same-store sales are expected to rise 6.2% this fiscal year, sending earnings per share 17% higher.
Yet Tiffany shares have tumbled from $140 in July to a recent $104 on concerns over a slowdown in China. That country brings in more than 15% of sales. Its tourists also buy Tiffany goods abroad for less than they would pay at home, a practice China's government appears to be cracking down on. Oppenheimer analyst Brian Nagel calls the China concerns legitimate, but the selloff a buying opportunity. It has left shares trading at about 21 times earnings, down from a peak of 27 times this past summer.
At Home Depot, the lumber and such isn't under threat from Amazon, but smaller items like hand tools are a target. That makes it important to lock up winning brands as exclusives. Rival Lowe's did just that last year when it struck a deal with Stanley Black & Decker (SWK) to sell Craftsman products, which Stanley had bought from Sears. In October, Stanley announced an exclusive deal with Home Depot to sell Stanley-brand hand tools and storage products in stores and online.
Simeon Gutman, who covers Home Depot for Morgan Stanley, calls Stanley one of the highest-rated tool brands online, including among reviewers on Amazon. More broadly, Home Depot continues to ride a years-long housing recovery, with same-store sales expected to grow 5.6% this year, and earnings per share, 31%. Shares go for 18 times earnings, and Gutman predicts 14% upside over the next year, plus the 2.3% dividend.
Best Buy has beaten back the bears with a 75% return, cumulatively, over five years. A surge in television sales has helped. So has a brisk trade in Apple gadgets. This year, same-store sales are expected to rise 4.2%, and earnings per share, 16%. And the stock looks attractively priced at 13 times earnings. The problem is that some key tailwinds could turn into headwinds next year. Television prices have been falling, which is good for unit sales in the near term, but not for revenue in the long term. Amazon recently announced a deal to sell Apple products directly. Best Buy's efforts to morph into a services company, providing smart-home installations and on-demand tech service, might be too new to offset a lull in traditional store sales.
Also unclear is whether "treasure hunt" retailers like TJX and Ross Stores (ROST) will continue to outperform. Both trade at over 20 times earnings, and have capitalized on the struggles of other retailers by buying overstock merchandise on the cheap, and reselling it to opportunistic shoppers at a profit. But better inventory management by retailers could cut into future opportunities for deals, and closeout stores can't match larger retailers in digital capabilities.
Avoid the mall, especially for department stores that don't sell differentiated goods. The outlook for J.C. Penney hasn't gotten much brighter since Barron's urged caution four years ago. The shares are down 85% since then, and Wall Street doesn't foresee a return to profitability soon.
If Kohl's is a template for attributes to favor in retailers from here, L Brands might serve as a cheat sheet for what to avoid. There's mall exposure, little digital innovation, rising competition, and a fading brand. Sales are badly slumping at the company's Victoria's Secret chain, while those for rivals that take a more inclusive approach to sizing and marketing, like the Aerie unit of American Eagle Outfitters (AEO), are taking off.
This past week, the CEO at Victoria's Secret stepped down after just two years, but the larger problem is that management at the parent company doesn't seem to acknowledge the bull market in body-positive fashion, and the recession in the appeal of supermodels.
One indicator will be the television ratings on Dec. 2, when ABC airs the Victoria's Secret Fashion Show, a yearly runway strut. Last year on CBS, the program's ratings plunged more than 30%, coming in below a rerun of Rudolph the Red-Nosed Reindeer.
A spokeswoman for L Brands says the show's global audience has been growing.
|For more news you can use to help guide your financial life, visit our Insights page.|