2 Retail Stocks To Buy, 1 To Avoid

 |  Includes: COST, SWY, TFM
by: Fusion Research

In the U.S., retail products account for approximately 30% of consumer spending, and it is expected to grow further with the recovering economy. Despite strong consumer spending, not all companies are performing well in this competitive market. Retailers are adopting various strategies to attract and retain consumers. We have scouted out three companies worth a closer look. What opportunities do these three retail companies hold for investors?

Expansion for incremental earnings

The Fresh Market (TFM) plans to expand its operations throughout the U.S. As per CEO Craig Carlock:

.....Our long term objective are to drive 15% unit growth and increase store comp sales by 3% to 5%. This coupled with modest expense leverage should allow us to drive meaningful earnings growth.

The company is on track to open 21-22 new stores by the end of this year. In the first quarter, it opened seven new stores, followed by three new stores in the second quarter. It plans to open 10-11 new stores in the third quarter and four stores in the fourth quarter. The Fresh Market's annual capital expenditure is expected to be in the range of $120 million to $140 million. With these expansion plans, the company is expecting unit growth of 15% to 17% and comps to be in the range of 2.5% to 4.5% this year.

New stores opening in the last two quarters have contributed 79% of the productivity on average. Its expansion blueprint to open new stores in the next two quarters will increase the productivity to 80% to 90% by this year end. With increased productivity, its earnings are expected to grow 15.64% by the end of this year, followed by 23% by the end of 2014. This earning growth will reduce the forward P/E to 31.18 from trailing P/E of 36.10.

We believe that The Fresh Market has planned its expansion throughout the year very effectively and will be able to achieve its long term objective of unit expansion and comps sales. Despite its heavy spending, the company will drive earnings growth as reflected in the decline of forward P/E ratio.

In line with the industry performance

According to Forrester, online sales in the U.S. are expected to grow 13%, reaching $278 billion by the end of 2013 and surging to $370 billion in 2017. Costco Wholesale's (COST) online business contributes merely 2.5% of its total revenue, accounting for $2.5 billion. To capitalize on online sales growth, the company is adopting strategies to promote its e-commerce website. Its prominent strategy is to keep distinct inventory on its website, separate from its retail outlets inventory. This strategy promotes customer interest towards both the website and stores, driving higher sales. In the second quarter of 2013, it reported distinct inventory of 80% to 90%, and revenue from online business increased by 20% quarter over quarter. It also launched an application for smartphone users. With the implementation of these strategies, the company is expecting its online business to contribute more towards its total revenue, accounting for 3.1% next year.

We believe, these approaches will drive incremental sales and will help the company to be in line with industry performance in terms of its sales and earnings. Its market capitalization is $48.85 billion and last year sales were $99.1 billion. With this, Costco's price to sales ratio is 0.49. The industry price to sales ratio is 0.60. Costco Wholesale has less ratio than the industry, implying higher sales than the industry average sales. Also, its forward P/E is expected to decline to 24.48 this year from trailing P/E of 28.25 last year, implying higher earnings.

Canadian Divestiture -- may be a wrong move

Safeway (NYSE:SWY) is shifting its focus towards its core business in the U.S. and wants to expand its market share in the U.S. For this, it sold 213 Canadian stores to Sobeys for $5.4 billion in June 2013. With these proceeds, it will pay its debt of $2 billion, which will reduce its interest expenses to $111 million in 2014 from $304 million in 2012.

Prices of U.S. grocery items are heating up, leading towards decline in consumer purchasing power. To attract customers, Safeway will be using a portion of funds from the Canadian divestiture to provide discounted grocery pricing. We consider this as short term strategy to gain customers, but in the long run, this strategy will cause margins issues that will lead towards a decline in its earnings.

On the other hand, its second quarter earnings were down by 93% quarter over quarter because of tough competition and tax liabilities related to this divestiture. It will also face margin pressures because its Canadian business has been more profitable than its U.S. business. With this, its same-store-sales declined 1% year over year.

Due to margins pressure this year, its earnings are expected to decline by 49.99%. It will also have an impact on the P/E ratio, which is anticipated to upsurge to 23.66 by this year end from 12.11 in 2012. The industry has a P/E of 17.70, which is less than the company's P/E. This implies than Safeway has generated less earnings as compared to the industry earnings average.


The Fresh Market and Costco wholesale are expanding and adopting various strategies to increase their sales. These strategies will drive the companies' earning growth, leading towards enhancement of the shareholders' value. On the other hand, Safeway is facing margin problems on account of its divestiture. Its earnings will also face pressure over the coming years, so we recommend holding the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.