I'm dreaming of a green Christmas--for these five retail stocks

11/02/2010 8:30 am EST


Jim Jubak

Founder and Editor, JubakPicks.com

Should you be getting your portfolio ready for Christmas?

If you’re like a lot of us, you’ve noticed that the stocks to own in this rally were things: commodity producers and the companies that made machinery for commodity producers. Brazilian iron ore miner Vale (VALE) was up 23% from the August 26 low to the October 29 close. Copper and gold producer Freeport McMoRan (FCX) was up 41% in the same period. Mining equipment maker Joy Global (JOYG) was up 32%.

I’m not urging you to dump those stocks out of your portfolio now. I think they should continue to do well in the fourth quarter as growth in the world’s developing economies drives demand for physical commodities and as a declining U.S. dollar and rising fears of U.S. inflation drive demand for commodities stocks.

But I do think it’s time to see how far your portfolio has drifted (Like Mae West: “I was Snow White but I drifted.”) toward an excessive allocation to a sector that is, whatever its prospects, more expensive than it was two months ago. And to add a few positions in a sector that has been largely overlooked in this rally and that is likely to do surprisingly well this quarter.

I mean retail.

This is retail’s time of year for lots and lots of volatility. The holiday shopping season is the time when retail stocks do really, really badly—if expectations are high and actual results are disappointing. And it’s the time when retail stocks do really, really well—if expectations are low and the actual results are surprisingly strong.

And that’s where I think we are this year. Expectations for the holiday season among investors are really low. Many of them have written off consumers completely saying they’ll never open their wallets again.

But this year’s holiday shopping season looks like it will be decent. Sales during the 2009 holiday season rose by just 0.4% from the previous year. This year the current forecast is for 2.3% growth from 2009. And the forecast might have some room to run slightly higher. At the beginning of October the forecast from the optimists was for a 2% increase this holiday shopping season. (See my post http://jubakpicks.com/2010/10/04/2-growth-in-retail-sales-doesnt-sound-like-much-until-you-compare-it-to-last-christmas/ ) The most recent GDP report for the third quarter, released on October 28, showed consumer spending growing at a 2.6% rate. (See my post http://jubakpicks.com/2010/10/29/third-quarter-gdp-comes-in-on-projection-unlikely-to-change-feds-decision-next-week/ ) Nothing here to knock you socks off but 2% is sure better than 0.4% and 2.3% is better than 2% and 2.6% is… well, you know.

Let me flesh out the argument for adding a retail stock or five to your portfolio this holiday season and give you five specific names to put under your tree.

Let’s start with a little more detailed look at why 2.3% retail sales growth this holiday season is likely to be enough to make holding retail stocks profitable.

I’m going to use Target (TGT) as my example because for most of the last decade it turned in revenue growth that was consistently ahead of the average U.S. retailer. According to Standard & Poor’s from fiscal 2004 (which ended in January 2004) to fiscal 2008, the company showed a compound annual growth rte of 10.6%. That all came to a crashing halt in fiscal 2009 when revenue climbed by just 2.5% and in fiscal 2010 (which ended in January 2010) when revenue climbed by a tiny 0.6%.

If you’re looking for a return to the glory days of fiscal 2004 through 2008 in the fiscal 2011 year that ends in January 2011, well, forget about it. Standard & Poor’s projects sales growth in the single digits for the year.

But even 5% looks good when the last two years have shown 2.5% and 0.6%.

Of course, as Target’s sales growth from fiscal 2004 to 2008 shows retailers don’t do business in Lake Wobegon where all stores are above average. Even if this holiday season is going to be surprisingly strong, some retailers are going to be (or continue to be) unsurprisingly weak. J. C. Penney (JCP), for example, will grow same store sales by just 2% in the fiscal year that ends in January 2011, according to S&P. It shouldn’t be surprising that Penney will lag Target in fiscal 2011. Penny has been a retail laggard for quite a while now. Five-year average annual sales growth at the company is a negative 0.6%. The industry average for the department store sector during the period is 8.3%.

Same goes on the upside. Coach (COH), which operates in a different retail segment (apparel footwear and accessories) than Penny or Target has averaged 16.9% annual sales growth during the last five years, according to Thomson Reuters. That beats the category average of 11.9% quite handily.

Let’s say we want to design a mini retail stock portfolio of five stocks. A good mix would include some high-growth momentum retailers like Coach. These stocks aren’t especially cheap but to investors looking for earnings growth and earnings momentum, these are the stocks to own. You’d also want to add a few lower-priced stocks that come with less risk but have are well managed and have a history of finding a way to take advantage of an improved retail climate.

My growth momentum picks start, no surprise, with Coach (COH). Here’s what I like most about the quarterly earnings the company reported on October 26. Yes, the 19% revenue growth for the quarter was great and the international story is just cooking along with eight new stores opened in China (total now 49) in the quarter. But what was best was the way the company trounced Wall Street projections in the supposedly slow growth U.S. market. Analysts were expecting 5% same store sales growth in North America for the quarter. That’s not exactly a low hurdle in this economy. But the company delivered 8.5% same store sales growth. Shares aren’t cheap at a price to earnings ratio of 19.8 times trailing 12-month earnings, but at a projected earnings growth of 21% in the fiscal year that ends in June 2011, they’re not expensive either, especially not for a momentum stock.

And you may not think of it as a retailer, but one of Apple’s strengths as a technology company is that it does. Apple stores are designed to create retail buzz. Its products share with fashion retailers an understanding of the need to generate not just excitement but also an image of cool. Just contrast the iPad to any of the competitive products. Apple sold a mind-bending 14.1 million iPhones during the recently completed quarter. And that’s while dragging the weight of the AT&T (T) wireless network behind it like a ball and chain. If money were no object, what piece of electronics would you give as a gift (or want to receive) for at the holidays? And if you had to scrimp and do without what would you buy. The pull back since October 18 is just 5% (from $318 a share to $301 on October 29) but it does give investors a good entry point. And if you can get past the $300 a share price to look at the numbers, you’ll see that Apple shares aren’t especially expensive at a price-to-earnings ratio of 20 on trailing 12-month earnings and 14 on forward earnings projections.

My first retail value stock is actually another play on Apple. Retailer Best Buy (BBY) is, to me, stunningly cheap at a trailing 12-month price-to-earnings ratio of 13 and a forward price-to-earnings ratio of 11. In recent years electronics have become “the” gift for the holiday season. (I think it’s got something to do with falling prices and increasing capabilities, but I’m not sure what.) Analysts are projecting just 12.7% earnings growth in the quarter that ends in February 2011. That seems low.

My second retail value stock is clearly a value stock, Family Dollar Stores (FDO). Operating in one of the intensely competitive discount retail segment at a time when its customers base was feeling the full brunt of the slow recovery, Family Dollar still managed to grow same store sales by 4.8% in fiscal 2010 to a projected 5% to 7% increase in fiscal 2011 and to improve its market position by shifting its merchandise mix and moving into new urban neighborhoods. The stock trades at 17.6 times trailing 12-month earnings per share and just 12.8 times forward projected earnings. Wall Street analysts are looking for 23.6% earnings growth in the quarter that ends in February 2011.

My last pick is Saks (SKS). I’d call this an extreme value play. The department store company didn’t come through the recession in good shape—it lost 42 cents in the fiscal year that ended in January 2010—and it’s not exactly going gangbusters now—earnings for fiscal 2011 are projected at 5 cents a share. But Saks seems to be in play. Diego Della Valle, the founder of Tod’s, disclosed on October 2 that he had increased his holdings to 19% of the company. Mexican billionaire Carlos Slim owns 16%. There are persistent rumors that private equity investment companies from the United States and the United Kingdom are circling. It’s not too far-fetched to imagine an offer.

It’s the season for visions of sugar plums after all.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. Coach is a member of my Jubak’s Picks portfolio http://jubakpicks.com/ The mutual fund I manage, Jubak Global Equity Fund (JUBAX), may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of the most recent quarter see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/ )

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