Stimulus Checks Save the Quarter for Retail

by: Zacks Investment Research

With several more retailers expected to report quarterly earnings this week, we sat down for a chat with Zacks senior retail industry analyst Rob Plaza, CFA for his outlook on the sector as a whole, and what his top Buy recommendations are.

Wal-Mart had a pretty good Q2. Does this indicate that other retailers should post stronger earnings this week and beyond?

What is good for Wal-Mart (NYSE:WMT) is not necessarily good for other retailers. Wal-Mart continues to perform well in this environment because of superior inventory management, logistics, and cost controls. This focus on operating costs give the company a huge competitive advantage, and the company passes along those savings to its customers. As a result, consumers shop at Wal-Mart to get more value for their dollar.

That said, Wal-Mart and most retailers should report decent results for the second quarter thanks to the government stimulus checks. I don’t think the momentum from the second quarter will continue into the second half of the year. That is an important point. The second quarter is the least important period in a retailer’s year. These companies rely on the back-to-school and holiday seasons for most of their profits.

How much of the quarterly strength would be attributed to the stimulus checks, do you think?

The stimulus checks saved the quarter for retailers. This doesn’t mean a shopper spent all of his/her check at the mall. Those checks helped the US consumer pay for gas, groceries, and credit card bills.

Put another way: What if consumers didn’t receive those checks? Retail results for the second quarter would have been awful. Unfortunately, the positive effects of those stimulus checks abruptly stopped in July and won’t help results in the second half of the year.

Wait a minute. Retail stocks have been rocketing higher for the last month or so. Doesn’t that mean we are out of the woods and it is a time to buy retailers?

No. I don’t believe this is the time to buy retailers. The time to be bullish was in June and early July. Some retail stocks are up 30% to 40% over the last month thanks to stimulus-aided second quarter results, falling commodities prices, and the belief that the economy may improve sooner than previously thought.

However, the consumer is still on the ropes and won’t ramp up spending this holiday season. Housing, household debt, and higher unemployment will continue to weigh on discretionary spending. To their credit, the retailers have tried to deal with these macro headwinds by controlling costs and inventory levels. That’s a good start, but I don’t think that will be enough to support the recent gains in retail stock prices. I would take profits in retail stocks.

Which companies are weathering the economic storm best thus far? Tell us about your top Buy recs.

Shoppers are still looking for value and ways to stretch their dollar. The most obvious plays have been the discounters and wholesale clubs. I’ll give two additional companies that offer value to their customers. One is my longtime favorite GameStop (NYSE:GME). Video games remain wildly popular (sales are up 36% in first half of 2008), due in part to their value for the dollar.

Compare buying a new video game to other entertainment choices such as a movie or amusement park. At $60, a new video game may look expensive, but it provides hours upon hours of entertainment for the players. In that light, video games are a cheap source of entertainment.

Another pick is (NASDAQ:PCLN), which is an online travel services firm. People still want or need to travel, and offers its customers deals on airfare, rental cars and hotels both here and abroad. Plus, it has William Shatner as its spokesman.

Any types of retailers that should continue to be avoided in the near term?

I would avoid those companies from which consumers are trading down, those with inventory problems and those with leveraged balance sheets. Specifically, I have Sell recommendations on JC Penney (NYSE:JCP) and Cost Plus (NASDAQ:CPWM). JCP shares are up about 45% off its July lows. JC Penney will continue to feel pressure from customers trading down to lower cost alternatives. Cost Plus is an overleveraged home furnishings retailer that has 25% of its stores in California. No reason to own this stock.

Rob Plaza, CFA is a senior analyst covering the retail sector for Zacks Equity Research.