Plaid is in vogue this fall season. Military themed wares have also caught on, even showing up to a degree in Banana Republic (go figure!). Although there is a sense of fashion in the malls and in discounters (by extension of course), the September same-store sales results are not displaying an aura of differentiation. Retailers largely surpassed consensus comp estimates, and a select few managed to upwardly revised 3Q EPS guidance. For the likes of Aeropostale (NYSE:ARO), Gymboree (NASDAQ:GYMB), and Target (NYSE:TGT) the merchandise is striking the proper chord with consumers (right price/must have) and operating expenses have been removed from the operating model.
All told, our retail sector coverage, comprised of specialty and discount, produced a -2.9% average comp for the combined August/September periods, which we feel is a truer indicator given the shift in the retail calendar for Labor Day. The number stacks up against a -0.7% comp in 2008 for the same periods; stripping out Wal-Mart (NYSE:WMT) from last year as the company no longer repots monthly sales and comps did in fact improve y/y, slightly. Part of the trend reversal could be attributed, in our view, to fewer deep promotions (sales=volume + price; the latter is helping at the moment). Retailers have gotten very creative in their promotions, offering for example buy one get one 50.0% off which brings consumers into the stores while preserving margin dollars.
Another item that stood out was online sales, increasing by robust amounts. Consumers continue to migrate from brick and mortar stores to capture deals on online, and who could blame them.
Online sales increases:
- Children’s Place (NASDAQ:PLCE): +54.0%
- Macy’s (NYSE:M): +14.8%
- American Eagle Outfitters: +13.0%
- Aeropostale (ARO): +62.0%
Long, Short, or Avoid Altogether Retail Stocks?
I am fast becoming concerned that valuations within the specialty apparel sector are ahead of themselves. The risk reward equation has shifted; retailers' haste to move merchandise last holiday season and continued promotions throughout 2009 have conditioned consumers to expect discounts. As a result, I am unsure how retailers will transition back to a more full-price strategy that is crucial in meeting consensus EPS estimates, which have been taken higher for next year. Retailers may in fact panic if inventory, said to be at “optimal levels”, does not fly off the levels on Black Friday or the week after leading to price wars part two.
Back on topic. Most of our sector coverage is valued noticeably above five-year normalized PE multiple averages. In a few instances, companies in the sector are valued higher than when they were producing peaking operating margins in the credit boom of 2006-2007. On the flip side, discounters are appearing attractive as we shift our gaze into 2010. The likes of Wal-Mart, Target, Costco (NASDAQ:COST), and 99 Cents Only Stores (NYSE:NDN) have not participated in the market rally as money funneled into specialty apparel names that sport a greater snapback potential to EPS. However, it’s important to note that discounters have greatly strengthened their operating processes, allowing them to squeeze out more profits on a lower base of sales. With the retail sector still trying to determine where the new baseline level of consumer spending will conclude (I think it’s safe to assume a 9.0%-10.0% savings rate later in 2010), I am inclined to recommend increasing exposure to discounters given potential top line and bottom line misses within specialty retail, which is not priced into valuations (a V-shaped earnings recovery for most is factored in based on our work).
Placing the ole economist hat on for a moment, the Federal Reserve released its latest consumer credit data yesterday afternoon. Many are quick to discount the data set as backward looking, which may be true, but I believe that argument does not give the report enough respect so to speak. Keep in mind, in order for retailers to ring the registers and drive returns for shareholders, either during back to school the holidays or a lazy summer month, credit expansion must play a pivotal role. The existing credit issue, reflecting the reluctance of banks to extend new credit or slash availability under revolvers, is a prime reason why I believe the road to recovery for retail sector sales and earnings may surprise to the downside in 2010. Remember, another ingredient in credit is the willingness of the consumer to pack on leverage; I am not sure if that’s currently a sought after proposition as debt from the last cycle is still present and weak job prospects/wage prospects remain at the forefront of the brain. The savings rate, which I forecast to peak near 10.0% in 2010, as well as the credit elements just outlined, suggests fewer winners in the retail sector. Essentially, less dollars sloshing around the malls and more dollars allocated to discounters, which have improved product quality and overall scale of products offered during the recession.
Consumer credit declined for the seventh consecutive month in August, this time by 5.8% year over year. Outstanding credit increased each month since 1997, peaking in August 2008.