Four Value Plays in Retail

03/31/2017 2:50 am EST

Focus: INCOME

John Buckingham

Editor, The Prudent Speculator

In his The Prudent Speculator newsletter, value investing expert John Buckingham reviews select opportunities in the retail sector — and shares the research notes he prepared for his latest appearance on CNBC.

We think that there are attractive names in the industry group for those focused on buying undervalued stocks in a broadly diversified portfolio; despite competition from online retailers, we believe that the improving health of the economy should put more dollars in consumers’ pocketbooks, and that selective retail stocks are solid long-term investments.

These can be broken down into a couple of categories:

1) Very inexpensive (deep value), high-dividend payers with a flat EPS outlook that are priced for imperfection.

Apparel merchant American Eagle Outfitters (AEO), which boasts a strong balance sheet with no long-term debt, a growth vehicle in its Aerie intimates stores that will likely help keep firm-wide EPS relatively flat for the next few years, a dividend yield of 3.7% and a P/E ratio of 11 on a stock that is off more than 10% this year.

Department store operator Kohl’s (KSS), which beat consensus EPS forecasts in 4 of the last 5 quarters, while generating substantial free cash flow that allows for significant share repurchases and dividends (the payout was just increased by 10% this year, with the yield now 5.9%).

The stock is trading for less than 10 times earnings, despite a super-high effective tax rate around 37%. Meanwhile, the stock is off some 24% this year.

2. Higher quality specialty retailers trading for reasonable valuations with solid EPS growth outlooks.

Athletic footwear and apparel vendor Foot Locker (FL), which has not had an earnings miss in 14 quarters, yet trades for a P/E of just 15, despite current analyst EPS growth projections in the high single-digit percentages for the next four years.

In addition to holding strong relationships with major shoe makers and operating with a tailwind of keen consumer interest in fitness, FL also owns a strong balance sheet that sports almost $7 per share of net cash, giving management operational flexibility and the ability to buy back shares.

The company just introduced a new $1.2 billion repurchase program and increase the dividend. FL also last month gave a double-digit boost to the payout and the yield is now 1.7%.

Cooking and home furnishings retailer Williams-Sonoma (WSM), which, despite ongoing weakness in its Pottery Barn business, just turned in better-than-expected quarterly results, due in part to strength in its West Elm brand.

Thanks to a terrific balance sheet with no long-term debt, management hiked the dividend by 5%, pushing the yield to 3.3%, and disclosed that $411 million remains under its current stock buyback program (which would amount to about 10% of the outstanding stock at today’s prices).

Further, solid earnings per share growth is likely the next few years, yet the shares change hands at less than 14 times earnings.

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