Retailers: Avoid This Sector, Then Look for Bargains

June sales tallies from retailers are set to be released on July 10, and in our view there will be a two part story. Right off the bat, we must say that investors should not foresee strong sales readings by any stretch of the imagination as June weather conditions were skewed towards unfavorable (there were pockets of warmth in key regions, though one must keep in mind the Midwest flooding and cool down in temperatures at month’s end).

So, the first part of the story will be second quarter earnings guidance. Retailers held their guidance ranges steady on the May sales releases as they awaited more appropriate temperatures in June. We expect a host of earnings warnings from specialty apparel retailers as they were quite aggressive in terms of promotional inducing measures during May and June. Department stores should follow in similar fashion to their smaller counterparts; we observed meaningful clearance sales at the likes of JC Penney (JCP) and Macy’s throughout the month. Big box retailers, such as Wal-Mart (WMT) and BJ’s Wholesale (BJ), could very well raise third quarter guidance due to their exposure to consumable goods and limited product markdowns.

The second part of the story consists of sales trends in early July. Many retailers will not provide such granularity, but those that do could help to shed light on traffic trends heading into the critical back to school selling season.

If we had to pull together a general trading thesis going into the results, our advice would be to avoid the sector. The likelihood of earnings warnings, coupled with uncertainty pertaining to back to school sales potential are ingredients for the market to send the sector lower. Provided this does hold true, we would then begin to scour the sector in search for bargains; note these perceived bargains would only be in companies executing very well and that offer a high probability of outperforming peers heading into the back half of the year.