Morgan Stanley research analyst Mark Wiltamuth and his team published a report titled “Retail, Food and Drug - 2012 Outlook: Stock Picks for Another Tough Year” on Dec 15, 2011. They have analyzed US-based retailers and have identified stocks amid tough industry dynamics. Their report screens defensive, growth and value stocks in the industry. Morgan Stanley believes that under weak economic environment, defensive stocks should be chosen, while Target (TGT) remains the most attractive value buy at this point in time. We will discuss the picks in two articles; this is the first.
Costco (COST) has been assigned an Overweight rating by Morgan Stanley, with a price target of $97, and has been identified amongst the three favorite defensive ideas for 2012. Morgan Stanley economists are forecasting another tough year for US, with 8.8% unemployment levels and a 2.2% GDP growth rate. Costco has been exhibiting strong sales trend backed by its upper income customers. Traffic at the stores has been increasing by more than 4% for the last two years, while market share in the food segment stood strong at 55%. Eighty percent of the company’s earnings are derived from membership fees that have been increased by 10%. This fee increase is expected to boost membership fee income by 12-15% going forward. Hence, company’s EPS is expected to increase by 12-16% over the next 3 years.
Family Dollar (FDO) has been given an Overweight rating by Morgan Stanley, with a price target of $67, and has been identified as another favorite defensive idea for 2012. In tough times, when consumers are economizing, retailers like Family Dollar perform better. Analysts forecast comps to accelerate going forward due to the growth program undertaken by the company. Moreover, growth in square footage is also expected to support sales growth and expansion of operating margins.
GNC Holdings Inc. (GNC) has been given an Overweight rating by Morgan Stanley, with a price target of $31, and has been identified as third favorite defensive idea for 2012. GNC is known as the leading retailer of vitamins and supplements. It is a story driven by a growing health/fitness trend, with industry-wide demand for vitamins and supplements increasing annually by 5-7%. Sales have recently increased by 8-10%, resulting in a significant earning surprise. The stock is expected to post 33% and 19% growth in EPS for 2011 and 2012 periods respectively. GNC now trades at 15x 2012 P/E estimates, exhibiting the lowest PE to Growth ratio in Morgan Stanley’s coverage universe.
The Fresh Market (TFM) stands as top long-term growth idea pitched by Morgan Stanley. It is assigned an Overweight rating with a price target of $45. The Fresh Market is a perishables-focused grocer with 107 stores. Analysts forecast 14-15% unit growth and 20-25% EPS growth over the next 10 years, with the potential to grow up to 500+ stores. Although valuations for this company remain on the higher side at 30x, 2012 P/E for its competitor Whole Foods (WFM) is also at 29x.
Target (TGT) stands as the top value idea pitched by Morgan Stanley, assigned an Overweight rating and a price target of $64. Analyst believes that TGT possesses the greatest re-valuation potential for the next 2 years. The stock is currently being penalized for its decision to tap the Canadian market and facing the challenges of lower P/E and EPS dilution. 2013 EPS for the company is expected to increase by 16-20%, while free cash flow is expected to double by 2014.
Walgreen (WAG) has been assigned with Underweight rating by the Morgan Stanley, with the price target of $29. Walgreen and Express Scripts are going through a dispute over pharmacy reimbursement rates. In case there is no agreement, and if Walgreens exits Express Scripts' retail network, Walgreen’s 90% of the 90M prescriptions filled by Express customers would be lost to other pharmacies. Such a scenario presents significant earnings risk to Walgreen.
CVS Caremark (CVS) has been given an Overweight rating by Morgan Stanley, with the price target of $45. In case Walgreen and Express Scripts do not reach a favorable agreement, CVS will benefit the most. Under such a fiasco, CVS is estimated to gain an EPS of $0.11/share. Moreover, the company will also gain from its PBM’s marketing advantage over Express, as CVS will offer its whole retail network compared to Express’ limited network. Jonathan Jacobson's Highfields Capital cut its CVS stake by 42%, but the fund still had more than $400 million invested in CVS at the end of the third quarter.