3 Retailers On Sale, Based On Mean Reversion

Includes: AEO, TRLG, WSM
by: Alan Brochstein, CFA

Consumer Discretionary stocks have been quite strong so far in 2012, with the sector up 11.2%, substantially ahead of the S&P 500's 8.5% gain through 3/5. As is always the case, performance hasn't been uniform. My philosophy when it comes to this sector, and especially retailers, is to use mean reversion. With this in mind, I looked for some laggards that don't seem like they are potentially terminal. Here are the parameters I used:

  • Market Cap > $500mm
  • YTD Price Return < 0% (lagging the sector)
  • 1yr Return > -5% (tracking over the longer term)

Here are the 3 retailers that made the cut:

Click to enlarge
Starting with the worst in terms of recent performance, True Religion (NASDAQ:TRLG) was pounded after they reported their Q4 results. The stock appears to be near support of 25-27 based on the weekly chart.

The earnings have slowed down as the company has been investing aggressively in store openings but are projected to pick up again in 2013. The current PE of 13.5 doesn't incorporate the very high cash balances, which equate to almost $8 per share ($200mm). The stock has a short-interest of 6%.

American Eagle Outfitters (NYSE:AEO) has a new CEO who will address investors for the first time on 3/7, when the company reports earnings. I like this choice a lot - Robert Hanson did a great job at Levi's and is likely to help the company expand internationally and to drive product innovation.

Teen retailing is a tough biz, but you sure don't have to pay much for it with this stock. While the PE of 16.6 looks high, it appears to be priced off of depressed earnings. Analysts project 20% growth over the next few years. Also, as of Q3, the company had about $2.50 cash. The stock has bounced nicely since early in the year, when it was slammed on weak December sales.

Williams-Sonoma (NYSE:WSM) also pulled back sharply when it preliminarily reported disappointing results for Q4, but it has completely recovered. The company will report its final results on 3/8. Like the other two stocks, it has a nice cash hoard at about $3.50 per share. While this stock looks a bit more expensive than the other two compared to its projected earnings, it also seems to face less competition.

While many speculate that the housing market is about to turn, which would seem favorable, pent-up demand even absent new households would seem to favor WSM. Sales are still well below the 2008 peak, and current expectations (6% top-line in FY13) seem modest.

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