The recent "melt up" in the market continued during last week's holiday shortened trading week. The trigger for last week's rise was a better than expected jobs report. In June some 288,000 jobs were created. Previous months' jobs reported were also revised up nicely. The headline unemployment rate dropped to 6.1%, roughly in line to where it was before the recession began. Job growth in the past five months has averaged more than 50,000 jobs more per month over the average for 2013. Job growth has accelerated since long-term unemployment jobless were allowed to expire at the end of 2013.
Under the surface, there are still some areas of concern. The U6 unemployment rate (the headline unemployment rate plus part-timers that want full time work) remains above 12%, significantly above where it was before the economy started to sink in late 2007. Part of this large population of part-timers is a direct result of the Affordable Care Act, whose impacts unfortunately are not going anywhere in the near future.
In addition, average wages have grown only two percent over the past 12 months. Given inflation this means the average consumer has made absolutely no headway over the past year despite improving job growth.
I think accelerating job growth is more than welcome but for the reasons cited above I am taking it with a big grain of salt. However, I have recently raised my rating on the retailing sector from Underweight to Equal Weight due to the sector's significant underperformance in the first half of the year and improving job growth and consumer confidence.
I think it is important to focus on the bifurcated nature of the retail market. Retailers like Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) that cater to low and lower middle class consumers should remain under pressure for the foreseeable future and should be avoided. Retailers targeting specific niches in the market and/or higher middle class or upper income groups are investable here. Here are three retailers I have in my portfolio.
Macy's (NYSE:M) is one of the few core retailers I have held for more than a year and has performed very nicely over that time. The company is probably the best-managed department store in the market and one of the few that has been able to successfully integrate its online business seamlessly into its overall offerings.
The customer base is mostly upper middle income consumers, which are doing better in this recovery than customers that typically make up the average customer at Sears (NASDAQ:SHLD) and other older retailing icons in this space like J.C. Penney (NYSE:JCP).
Earnings are projected to rise a bit over 10% year-over-year both in FY2014 and FY2015 on revenue gains in the low single digits. The shares go for just over 13 times forward earnings, an approximate 20% discount to the overall market multiple. The stock also yields a satisfactory 2.1% dividend yield and the company has raised its payouts aggressively over the past few years.
I also own PetSmart (NASDAQ:PETM) here. Pets have made out better than most consumers during this weakest on record post war recovery. Pet spending is growing 4% to 5% annually and now stands at more than $35B a year. Pet ownership continues to grow faster than household formation or disposable income as well.
I was very happy to see activist fund Jana Partners take an almost 10% stake in PetSmart this week. Barron's also recently called out this retailing stock as undervalued. The company is getting a growing amount of overall sales from offering services (grooming, boarding etc..) that cannot be matched by online retailers.
Jana Partners is currently pushing for a sale of the company for a significantly higher price. Given that private equity firms hold more than $1T in "dry powder" and the consistency of the company's cash flow, this push could have legs. In the meantime, the shares are not expensive here. The shares trade at less than one times annual revenues, yield 1.4% and PetSmart has little net debt on the balance sheet.
I also recently took a stake in Coach (NYSE:COH), which I recently detailed on Seeking Alpha. The retailer is struggling against the likes of Michael Kors (NYSE:KORS). However, its customers are in the right socioeconomic groups and this retailer could be a prime target for activists like Jana Partners as well. In the meantime, the shares pay near a four percent (3.9%) dividend and sell at around 10 times trailing earnings.
Disclosure: The author is long COH, M, PETM. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.