The Trade-Down Effect

Includes: AAN, FDO, LL, NDN
by: Dan Weiss

In recent months we have seen soaring fuel and food prices, declining home prices and home equity, a fairly high increase in the unemployment rate and an economy which has slowed considerably from its levels just a few months earlier. Yet at the same time, we are seeing the consumer holding up better than many folks had anticipated. So where are people spending money?

Obviously, some of this is due to an increase in gasoline purchases, but we also see some strength out of select retailers on the very high end where a falling dollar has made US goods less expensive for foreign tourists, and then we see relatively healthy growth out of some of the so-called trade down retailers who benefit from consumers looking for better bargains. Some of these trade down retailers such as Wal-Mart (NYSE:WMT) or Big Lots (NYSE:BIG) along with the wholesale stores (BJ's, Sams Club, Caustic, etc.) and to a much lesser degree Target (NYSE:TGT) are obvious beneficiaries, but so are price leaders in other area, and they may not be obvious candidates.

Examples of some companies who are doing well because of the trade-down effect are in the home supply business- Lumber Liquidators (NYSE:LL), a price leader among hardwood flooring companies, Aaron Rents (RNT)in the rent-to-own space has benefited in part due to Wal-Mart's decision to remove layaways and in part due to the tighter credit standards. Somewhat surprisingly, we have not yet seen significant strength in some of the so-called dollar store retailers such as 99 Cents Only Stores (NYSE:NDN) or Family Dollar (NYSE:FDO), although I would not be surprised to see a pickup in time.

Some other areas that may continue to do well in the retail space are in the auto supply and parts area, since consumers are not buying as many new vehicles and are therefore increasing their shopping for parts to fix up their automobiles. There are many other areas that may experience similar trade-down effects such as retailers in the travel and leisure space, casual dining and potentially even the alcoholic beverage area.

Until we see a retreat from $4 per gallon gasoline and improvements in the overall economy, it is likely that these companies will continue to be the winners in the retail space. I continue to be a believer in the space, but at the same time I continue to look for signs of improvement in the economy to potential shift money into other retailers or potentially into financial names.

Disclosure: Author is long both Lumber Liquidators and Aaron Rents.