Heeding Doug Kass: 3 Retailers to Avoid

Includes: ETH, LULU, VRA
by: Bret Jensen

Doug Kass recently revealed that he is short retailers due to declining saving rates, sluggish personal income growth (that is mainly due to government transfers), and rising inflation. Here are three stocks in the sector that I believe are particularly vulnerable.

Ethan Allen (NYSE:ETH) - Ethan Allen Interiors Inc., together with its subsidiaries, engages in the design, manufacture, sourcing, sale, and distribution of various home furnishings and accessories, as well as related marketing and brand awareness efforts in the United States. The company also markets home furnishings and accessories to consumers through a network of company-owned design centers. Its products include beds, dressers, armoires, tables, chairs, buffets, entertainment units, home office furniture, and wood accents. The company also offers upholstery home furnishing items, such as sleepers, recliners, chairs, sofas, loveseats, cut fabrics, and leather, as well as home accessory and other items, including window treatments, wall decor, lighting, clocks, bedding and bedspreads, decorative accessories, area rugs, and home and garden furnishings.

Valuation – Ethan Allen is selling at over 39 times 2011’s projected earnings and a little over 26.5 times next year’s consensus. The company lost money in 2009. Sales have contracted at an average 12% over the past five years. Earnings have contracted at a much faster pace over the same time period. It is selling at the top quarter of its five year valuation based on P/E, P/B, and P/S. It’s selling at over a projected 2 PEG. Given the moribund housing market, rising gas prices and slow family formation, it is hard to see a turnaround in the domestic residential housing market anytime in the near future. Ethan Allen is at almost 40 times this year’s projected earnings, which leaves it vulnerable to a pullback. Indeed, consensus earnings for 2011 and 2012 have been reduced over the past ninety days.

Vera Bradley Designs (NASDAQ:VRA) - Vera Bradley, Inc., through its subsidiary, Vera Bradley Designs, Inc., engages in the design, production, marketing, and retail of functional accessories for women under the Vera Bradley brand. Its products include a range of handbags, accessories, and travel and leisure items. The company sells its products to independent retailers located in the United States, as well as to national retailers and third party e-commerce sites. As of January 29, 2011, Vera Bradley, Inc. sold its products directly through 35 full-price stores, four outlet stores, verabradley.com, and an annual outlet sale in Fort Wayne, Indiana.

Valuation – VRA sells at over 39 times this year’s earnings and over 32 times 2012’s projected earnings. This company recently completed an IPO. Insiders have used the expiration of lockup provisions to sell 28% of their shares over the past six months. In addition, its operating cash flow has gone down from the previous fiscal year. Vera Bradley goes for 5.5 times trailing revenues and a projected PEG of over 1.6. Given the slowdown in consumer spending, rising gas prices and slowing economic growth; it does not seem the time to invest in a luxury retailer that is valued at $50mm per existing store.

Lululemon (NASDAQ:LULU) - Lululemon Athletica Inc. engages in the design, manufacture, and distribution of athletic apparel and accessories for women, men, and female youth in Canada, the United States and Australia. The company’s apparel products include fitness pants, shorts, tops, and jackets for healthy lifestyle activities, such as yoga, running, and general fitness. Its fitness-related accessories comprise an array of items, such as bags, socks, underwear, yoga mats, instructional yoga DVDs, and water bottles. The company sells its products through its retail stores, which are independent franchises; a network of wholesale accounts that includes yoga studios, health clubs, and fitness centers; and directly through e-commerce. As of January 31, 2010, it operated 124 company-owned and franchise stores under the Lululemon athletica and Ivivva athletica brand names.

Valuation - LULU sells at 45 times this year’s earnings and 40 times 2012’s projected earnings. It is still valued at over 9 times trailing revenues even after a recent sell-off. The sell-off was triggered by a downgrade by a FBR analyst who put a price target of $80 on the equity. I believe LULU is priced to perfection and the slowdown in consumer spending, primarily caused by higher energy prices, will leave this high priced retailer particularly susceptible. During the gas price run up in the first half of 2008, LULU lost over 50% of its value. It is also hard to feel comfortable investing in an apparel and yoga wear outfit selling at approximately $50mm per existing store, regardless of its growth prospects. Insiders have unloaded over 1.5mm shares over the previous six months.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.