The month of February provided much optimism for the retail segment, as U.S. retailers posted their best monthly sales performance since just before the recession started in 2007. Three-quarters of the 28 retailers in the Thomson Reuters index beat expectations, with the index’s same store sales up 4% in February, compared with expectations for a 2.9% rise. It seems that people are not too busy tending to their budget to go out to splash $200 on a pair of jeans at Nordstrom (NYSE:JWN), or a set of jewelry at Tiffany (NYSE:TIF) to please the loved ones. After all, Valentine’s Day falls in the month of February. It seems, too, that teenagers did not want to be left behind with the spending spree, helping boost sales at Abercrombie & Fitch (NYSE:ANF), American Eagle Outfitters (NYSE:AEO) and Aeropostale (NYSE:ARO).
While some were quick to point out a recovery in consumer spending, others were more cautious in assessing how much of a recovery has been priced in retail stocks. First, while the positive comps growth of most retailers is pleasing, it came as a result of easy comparisons, with the base period comps down 4.7%. Second, tax refund checks are either making their way to tax-payers’ mailboxes, or have already made their way to cash registers at the shopping malls. With refund checks being sent out as early as the end of January, it is safe to assume that some of these checks contribute to the comps growth. Therefore, the question that remains is, when comparisons normalize and tax refunds fade, what is the real level of sustainable growth for the country’s retailers?
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Year-to-date, XRT, the S&P retail ETF, has outperformed the S&P 500 index by about 1100 basis points, reflecting renewed optimism for the retail segment. At current valuations, XRT is trading at a price implying expected median sales growth of 10.77% for its constituents for the next 5 years, 280 bps higher than what was achieved in the last 5 years (please refer to the Implied Sales Growth chart). Double digit growth is a high hill to climb, in our view, given the US housing market is still hovering around the bottom, and the unemployment rate is estimated by most economists to stay above 9% in the foreseeable future.
The easy money likely has been made in the retail segment. It is time to be cautious.
The following chart displays the historical annual sales growth median metrics for XRT’s 64 member retailers for the past 14 years. The blue line represents the median sales growth of each year. The red dotted line reflects the median sales growth for the past 14 years, and the yellow solid line shows the median sales growth for the last 5 years. The red point reflects the implied sales growth, or the sales growth that is required to justify the current price for the median XRT constituent, assuming 5-year historical median EBITDA margin and asset turnover.