The S&P Retail Index was up about three percent for the quarter, while the S&P 500 was down half a percent. Of the approximately 300 stocks in the retail sector, 31 stocks went up more than 25% during the quarter (see Table). These 31 stocks were analyzed to determine if their rallies had staying power going forward, or they would most likely fizzle out or correct based on valuation. The following are the best buy and sell ideas based on that analysis.
Sell Rite Aid Corp. (RAD): RAD operates the third largest retail drugstore chain in the United States with 4,714 stores in 31 states offering prescription drugs, convenience products and cosmetics. The company is drowning in a sea of debt, with much of it incurred during its ill-fated debt-financed acquisition of Eckerd Drug and Brooks Pharmacy stores in 2006. That acquisition added 1,858 stores to its 3,333 stores while debt ballooned from $3.1 billion prior to the acquisition to its current $6.3 billion, which is over five times its equity market capitalization of $1.2 billion. The company’s quest to be the #1 drugstore chain with the debt-financed acquisitions, meanwhile, remains a dream as revenues have fallen for each of the last three years and are projected to continue falling by another 2%-3% next year. Competitors Walgreen Company (WAG) or CVS Caremark Corp (CVS), both with less debt and better operations than RAD, continue to gain market share, relegating RAD to the #3 spot. Furthermore, with the ballooning debt, debt service costs continue to rise, and the company continues losing money like a sieve loses water, losing a total of $1.7 billion in the last three years. RAD, meanwhile, has not shown any serious interest to get out of this debt quagmire. It has continued to push the ‘debt’ can down the road by extending debt maturities, while hoping that its new in-store initiatives generate growth to service the rising debt. This does not seem plausible, at least in the short-term, given the difficult economic climate and healthcare market in the U.S. The company has few viable initiatives, possibly including a sale of a significant portion of its stores to a competitor like Walgreen Company (WAG) or CVS Caremark Corp. (CVS). While this would lower its debt and debt service costs, it would also lower its revenue base and place it at a distant third to WAG and CVS.
Of the seven analysts covering RAD, five rate it a hold, one at underperform and one at a sell. Their target for RAD is in the $1.20s. Furthermore, high alpha or guru funds that have a long-term track record of beating the market are under-weight RAD by a factor or 3 as they hold only $11 million worth or about 1% of the stock. The stock was up over 25% during the quarter, and currently trades at $1.30. We would be sellers into any rally above $1.50, as we believe that the long-term outlook for the stock continues to be negative as long as the debt issue remains unresolved.
Sell Green Mountain Coffee Roasters Inc. (GMCR)
: GMCR operates in specialty coffee industry in the U.S. and internationally. It distributes approximately 200 whole bean and ground coffee selections, cocoa, teas and coffees. It is probably most famous for its patented single-cup coffee and tea brewing systems for offices and homes sold under the Keurig brand name.
This is a great growth story stock, and possibly a good long-term play, but we believe that in the short-term, the stock may a bit ahead of its fundamentals. GMCR sells at a forward 44 P/E, a 90 trailing twelve-month P/E, and at 7-8 times its current revenue. Both revenue and earnings have grown strongly, with earnings almost doubling every year since 2008. The stock, meanwhile, has responded very well to the improving fundamentals, with a parabolic rise of over ten-fold from $8-$9 range in early 2009. While GMCR is a story stock, with some even calling it the next Coca-Cola (KO), and there might be serious long-term upside in the stock, it appears that in the short-term, the downside execution risk outweighs the upside opportunity, as the stock is priced for perfection.
Of the eight analysts covering GMCR, eight rate it a buy/strong buy, two a hold and one at a sell. Their mean target on the stock is $92, reflection our contention that the stock is probably fully priced. Furthermore, high alpha or guru funds that have a long-term track record of beating the market are under-weight GMCR by a factor or 2.5 as they hold only $141 million worth, or just over 1% of the stock. We would be sellers here and into any rally, looking for accumulating the stock at much lower levels.
Buy Conns Inc. (CONN): CONN operates 76 stores in TX, LA and OK, and offers home appliances, consumer electronics and lawn and garden equipment. It trades at a forward P/E of 15, about mid-range based on its historic P/E range. The primary concern in the case of CONN is its accounts receivable, as the company is not only a retailer, but also a finance service company as it finances about two-thirds of its customer purchases either through itself or via third parties. The stock has taken a severe beating since peaking at $44 in 2006, falling as low as $3 in the 2008/09 crisis when there was great concern that many of these customer receivables would go into default. As the economy improves, the value of CONN’s receivables should also improve, as the customer default rate would go down and the earnings from interest on these loan receivables flows to the bottom-line. Moreover, revenue and earnings from its retail operation will also go up as the economy improves. We believe that CONN is under-valued at these levels, and that the rally last quarter may just be the beginning of a longer run-up in the stock price as the economy improves. Other Companies: Of the remaining, some companies for example, like mattress retailer Select Comfort Corp. (SCSS), membership warehouse club operator Pricesmart Inc. (PSMT), Dominos Pizza Inc. (DPZ), and Krispy Kreme Doughnuts (KKD) are showing good operating performance, but are trading at premium valuation and do not have enough upside to be recommended as a buy at current prices. Others, for example, like Lululemon Athletica (LULU), have had parabolic moves up and are extended, but they have strong tail-winds driving their fundamentals that may keep improving for years to come, making them a difficult short.
End-of-Quarter Price on June 30, 2011
Price Change During Quarter
YTD Price Change
Barnes & Noble Inc Com
Perfumania Hldgs Inc Com New
Select Comfort Corp Com
Pizza Inn Inc
Dgse Companies Inc Com
Green Mtn Coffee Roasters In Com
Bravo Brio Restaurant Group Com
Dominos Pizza Inc Com
Red Robin Gourmet Burgers In Com
Vitamin Shoppe Inc Com
Krispy Kreme Doughnuts Inc Com
Lithia Mtrs Inc Cl A
Ulta Salon Cosmetcs & Frag I Com
Bjs Restaurants Inc Com
Liquidity Services Inc Com
Spartan Stores Inc Com
Hot Topic Inc
Caribou Coffee Inc Com
Americas Car Mart Inc Com
Tiffany & Co New Com
Lululemon Athletica Inc Com
Rite Aid Corp
Credit: Historical fundamentals, including operating metrics and stock ownership information were derived using SEC filings data, I-Metrix® by Edgar Online®, Zacks Investment Research, Thomson Reuters and Briefing.com. The information and data is believed to be accurate, but no guarantees or representations are made.
Disclaimer: Material presented here is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion. Further, these are our ‘opinions’ and we may be wrong. We may have positions in securities mentioned in this article. You should take this into consideration before acting on any advice given in this article. If this makes you uncomfortable, then do not listen to our thoughts and opinions. The contents of this article do not take into consideration your individual investment objectives so consult with your own financial adviser before making an investment decision. Investing includes certain risks including loss of principal.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.