By Mike McDermott
This week we received monthly sales figures from a number of key outlets and the results were very interesting… The overall level of holiday sales were below 2010 levels but more importantly, there were significant differences between the types of retailers that did well or fell behind.
Last week we laid out five themes for the coming year. One of the key issues that we outlined was an adjustment by retailers to account for the disappearance of the middle class in the US.
Consumers today are likely to fall into a binomial model with one of two extremes. Either they are healthy spenders with stable jobs and plenty of discretionary spending power, or they are struggling to keep it in the road and looking for deep value every time they pull out their debit card.
The mixed results this week show that retailers are in fact seeing this dynamic in play and scrambling to adjust to the new consumer environment. For the most part, retailers catering to the middle class saw disappointing results while chains that are focused on offering deeply discounted merchandise saw gains. The luxury retail environment may be particularly challenging as a number of mid-tier retailers attempt to “trade up” to compete with the higher class retailers.
From a trading standpoint, it’s important to begin building a list of expected winners and losers in this environment – and then scanning the charts on a daily basis for entry points with good reward-to-risk dynamics. It’s still a difficult period to buy breakouts or short breakdowns.
The market is still showing too many “reversion to the mean” tendencies. But isolating names that have already broken out of patterns, and then entering after a pullback or consolidation offers two advantages:
- It creates an entry point that triggers on the second move – when a bullish stock follows through on a breakout, or the opposite for a bearish breakdown. This second move is more likely to continue in the direction of the trend, resulting in a higher probability trade.
- It creates a more definitive risk point. If a stock breaks to a new high, consolidates for 5 trading sessions, and then continues higher; a trader can reasonably expect the low of the consolidation to be a significant technical barrier. In this case, a long position can be entered with a relatively tight stop – giving the entire trade a better “R” – or reward-to-risk probability.
Let’s take a look at a few of the retail stocks that are setting up on either side of the ledger:
American Eagle Outfitters (AEO) was one of the primary disappointments on Thursday when the sales figures rolled in. For both November and December, AEO said same store sales were up 12% over the same period last year. So far so good…
But the company cut profit expectations for the quarter (which ends Jan 31), due to heavy promotions in the two weeks leading up to Christmas. Management said competition was particularly intense, so the discounts were necessary to keep inventory moving.
The stock gapped down well over 10% on Thursday and while the stock finished the day at the high end of its range, the technical damage was still significant. AEO is now well below the key 50-day EMA, and investors are losing confidence as analysts revise their earnings models lower.
Before the sales figures were announced, AEO was approaching the 2011 high and sentiment appeared to be quite bullish. Considering the dramatic shift, it will likely take time for institutional holders to adjust their positions and for many to liquidate their holdings. A 3-5 day pause followed by a new leg lower would be an attractive shorting pattern – depending on the bullish or bearish action in the broad market.
Kohl’s Corp. (KSS) is another good example of a “middle-of-the-road” retailer that is floundering in this environment. The company announced a 0.1% decline in same-store-sales, which was significantly below the positive expectations of 2.2%. Kohl’s lowered fourth quarter profit forecasts by about 10% and the stock continued to slide.
The casual retailer occupies an extremely difficult are of the market right now. The company offers “quality” products at an “affordable price.” The majority of sales come from apparel and accessories – and the “quality” market for these products is shrinking fairly quickly.
From the perspective of the deep discount shopper, Kohl’s products are a bit too pricey. Sure, the clothes may look a little better – and they may offer a better value if they last longer. But when consumers are struggling to make the mortgage or rent payment and keep food on the table, true “value” means whatever I can buy at the cheapest price right now.
KSS investors have had a difficult holiday season with the stock dropping 17% from the November highs. Analysts are still projecting earnings growth for the company over the next year, but confidence is declining – and it’s difficult to justify any premium price for this middle-of-the-road retailer.
Watch for KSS to consolidate, and consider rolling out short positions any time the stock approaches the 50 EMA or a previous swing high.
On the positive side of the ledger, we have both the deep discount boxes – along with a handful of luxury retailers that are executing their strategy extremely well…
Ross Stores (ROST) hit a new all-time high Thursday after the company reported December same store sales increased by 9% over last year. This was significantly higher than the 4% analysts were expecting.
Management increased earnings guidance for the fourth quarter (ending January 31) and analysts have subsequently increased their expectations for the year ahead.
Ross stores has been able to successfully market its “Dress for Less” concept – offering identical clothing at 75% less than typical department store price tags. The concept has helped to drive higher traffic and exceptional revenue growth – and the company has kept costs to a minimum in order to keep margins healthy.
From a trading standpoint, it’s difficult to jump into ROST right now. The stock is trading at a relatively high multiple for the industry right now (16 times fiscal 2013 expectations), and with ROST hitting a new high, it’s difficult to find a reasonable risk point for any new entry.
Keep the stock on your watch list, because a pullback to the 50 EMA could offer a great buying spot with a reasonable risk point. In November, the stock pulled back to $42 – right at the key moving average line – before vaulting 20% in a month. This is the type of move that allows for high “R” trades, with profits many multiples above the amount of capital initially at risk.
On the luxury retail side, Coach Inc. (COH) is setting up an interesting pattern. The stock has been setting up a wedge consolidation since early November, and the company continues to have success selling its premium handbags and accessories to affluent customers around the world.
COH is trading with a relatively high multiple (15.73 times expected earnings for June 2013 fiscal year), but that multiple can be justified by Coach’s reliable growth. Ironically, while some consumers are struggling to keep the home fires lit, wealthy consumers are often concerned with “keeping up appearances” – making sure their peers don’t suspect financial hardship.
Since Coach has a truly international presence, they are more diversified than many US or European-based retailers. A growing affluent community in Asia helps to drive demand for luxury goods, and Coach is taking advantage of this new consumer segment.
Friday’s action pushed COH above recent consolidation and may offer an exceptional buy point. Considering the way global stocks held up relatively well (despite a new low in the euro last week), stepping into a long position here may be a great trade opportunity.
The differentiation between different retailers makes it difficult to trade this sector from a broad perspective (using XRT or RTH as retail proxies), but it offers tremendous opportunities when looking at individual retailers. I’ll be keeping a watch list dedicated to a wide assortment of retailers this quarter. The key is to do the homework before the action breaks – so execution can be efficient and seamless.
Disclosure: As active traders, authors may have positions long or short in any securities mentioned. Full disclaimer can be found here: http://mercenarytrader.com/legal/