The Consumer to the Rescue?

06/29/2009 1:00 pm EST

Focus: STOCKS

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

Elliott Gue and Benjamin Shepard of Personal Finance say some retailers have what it takes to survive consumers’ belt tightening.

Consumer spending accounts for 70% of the US economy. Month-over-month consumer expenditures slumped late last year, contributing to the severe economic contraction in the fourth quarter. After years of profligate spending, consumers finally focused on paying down debt and saving money.

But the American consumer isn’t dead. The rate of decline in consumer expenditures has slowed markedly since late 2008. The Conference Board’s index of consumer confidence jumped to 54.9 in May, up from less than 40 at the beginning of the year. Rising confidence typically leads spending by a few months.

Some retailers won’t fare well in this more subdued environment. But retailers that sell bargain merchandise continue to benefit handsomely from frugal consumers. Meanwhile, those with strong brand names and conservative balance sheets have the wherewithal to survive the current downturn and position for growth when spending ticks higher late this year.

Off-price retailers like Ross Stores (NSDQ: ROST) purchase excess inventories of brand-name consumer goods from retailers, manufacturers, and vendors for pennies on the dollar. These stores then resell that merchandise to consumers at slightly higher prices.

Weak consumer spending in late 2008 and early 2009 left many retailers and vendors sitting on piles of unsold inventories. Amid that glut of closeouts, Ross has been able to negotiate even deeper discounts on its purchases [and] purchase brand names that had been unwilling to sell through Ross. Ross also has been actively cutting inventories it holds at its stores and warehouses.

Leaner inventories allow Ross to change its offerings more frequently to keep consumers’ interest. Reduced inventories also mean the company is less likely to get stuck having to discount merchandise for clearance. Ross recently boosted its guidance for earnings and same-store sales growth for both the second quarter and full year 2009. Ross Stores is a Buy under 45. (It closed above $38 Friday—Editor.)

With no debt and more than $600 million in cash, Bed, Bath & Beyond (NSDQ: BBBY) not only weathered a 2.4% decline in same-store sales last year; it opened 67 new locations, primarily in markets vacated by troubled competitors.

In 2009, the company expects to slow expansion to just 50 new stores in the US and Canada. Instead, it will focus on streamlining costs and inventories and consolidating some underperforming locations. Selling, general and administrative (SG&A) costs—a major profit drain in the retail business—have historically run in the high 20% range; this figure rose to 30.5% of net sales last year as consumers used coupons and other discounts. Bringing SG&A expenses down by just [one percentage point] could add as much as $70 million to top-line profits.

While sales growth will likely continue to moderate over the coming months, Bed, Bath & Beyond will be an excellent play on recovery in both retail spending and the real estate market. Bed, Bath & Beyond is a Buy below $32. (It closed around $31 Friday—Editor.)

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