Prudent Picks in Retail

06/05/2014 8:00 am EST

Focus: STOCKS

Chris Quigley

Contributing Editor, The Prudent Speculator

The retail sector has taken it on the chin, with several of our holdings reporting results that disappointed investors; inclement weather and weak economic growth played a major role, suggests Jason Clark and Chris Quigley in The Prudent Speculator.

American Eagle Outfitters (AEO)

American Eagle Outfitters tumbled even though the apparel retailer reported earnings per share of $0.02 and $646 million in sales, which were near respective analyst earnings expectations.

The stock-price slide was due in large part to weak mall foot traffic and a competitive pricing environment and, as a result, margins fell from 39% to 35% and same store sales dropped about 10% from the same period a year earlier.

It's clear that the company faces intense competition from other teen fashion stores and AEO has been working hard to cut costs in order to stay competitive, especially as price-sensitive teenage shoppers continue searching in earnest for trendy outfits at bargain prices.

All hope of an earnings recovery is not lost, in our view, and the company still offers investors much to get excited about. The search for a new Chief is well underway, and the results from its cost-cutting measures are starting to show on the bottom line.

We believe that AEO shares offer an attractive long-term opportunity; we remain smitten with the balance sheet, which sports no debt and some $328 million (more than $1.60 per share) of cash and short-term investments, and the 4.6% dividend yield.

Target (TGT)

Discount retailing giant Target saw quarterly profits fall 16% from a year ago, largely due to difficulties with its Canadian operations and lingering effects from its massive data breach last year.

When Target decided to enter the Canadian market, a combination of great brand recognition and relatively better pricing seemed to be a recipe for success; unfortunately, that hasn't been the case.

Inventory management has been poor, leaving many shelves bare and customers have not been pleased with the overall shopping experience. Alas, it all showed on the bottom line: Target lost nearly $1 billion in 2013 (before interest and taxes) up north and another $211 million, so far, in 2014.

While the start to the Canadian operations has been disappointing thus far, we believe that new management will rectify the situation in short order. In our view, the long-term potential for the Canadian market is good.

TGT trades at attractive valuation multiples compared to its historical averages and yields 3.1%. Our Target Price is now $79.

Wal-Mart Stores (WMT)

The world's largest retailer, Wal-Mart, saw its shares drop after reporting that bad winter weather, sluggish sales abroad, and food-stamp cuts contributed to a 5% profit decline during Q1 2015.

WMT shares trade below 15 times reduced earnings forecasts and offer holders a 2.5% dividend yield. With many consumers looking for a bargain, we believe Wal-Mart will continue to drive a lot of traffic.

And with its economies of scale and potential value-added operating initiatives starting to take hold, we think WMT shares will provide desirable and relatively stable long-term returns to patient investors. Our Target Price is $91.

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