2 Bargain Retail Stocks Ready to Grow

10/07/2011 10:50 am EST

Focus: STOCKS

Marc Gerstein

Editor, Forbes Low-Priced Stock Report

If you ’ve felt lately that the market has been beating up your low-priced stocks almost indiscriminately, without regard to company-specific merit, you’re right. But it’s not likely to be sustainable, writes Marc Gerstein of the Forbes Low-Priced Stock Report.

We can recognize our frustrating performance for what it is: an especially pronounced aversion on the part of investors to riskier equities, based not on day-to-day business factors, but the confluence of big-picture economic worries.

As investors monitor big-picture developments, they decide one way or the other to own or not own low-priced stocks as a sub-asset class, without concern for which specific low-priced stocks they’re buying or selling.

As seen, this is not unprecedented. But it’s also not indefinitely sustainable, and that is the reason why I’m staying the course in terms of stock-selection.

Charming Shoppes (CHRS)
A well-established retailer of plus-sized women’s apparel, CHRS ought to be a slam dunk. It’s well known that many Americans fall into that category, and it’s apparent to just about anyone who shops that most apparel retailers are not terribly effective in serving these consumers.

We’ve done well with a prior choice of Casual Male (CMRG), which serves “big and tall” men. One would think CHRS ought to likewise be right up our alley.

But there’s a catch. Charming has been around longer than CMRG, and its sales base is up in the neighborhood of $2 billion. So why is the stock trading in our low-priced range?

The answer: execution. The wheels came off in the late 2000s. The economy is partly at fault…consumers have had it tough in recent years, and we still can’t be sure they’re out of the woods.

But that’s not the whole problem. The company has made a lot of mistakes on its own, particularly in the areas of inventory control, merchandise selection, and loss of focus on the core Lane Bryantbrand.

So in essence, the story here centers not so much on the benefits of a plus-size focus, but on the notion of a turnaround play.

When turnaround is on the table, it would seem reasonable to wonder about management. As we’ve seen with some other turnaround-oriented companies, there’s been recent change here too, with a new CEO as well as new blood elsewhere in the organization.

The inventory problem is being aggressively addressed, perhaps too well for some on the Street. Inventory costs on a comparable-store basis were down 5% in the latest period.

A corollary to this was a top line that was lower than the Street expected, as CHRS refrained from aggressively marking prices down, as did other retailers. Margins were up year to year, as were per-share results.

As to brand focus, resources are being moved more toward the flagship Lane Bryantbrand, which focuses on the 35 to 55 age group and seeks to balance fashion and value.

A sister brand, so to speak, is Cacique, which features intimate apparel for the core Lane Bryantcustomer (Caciquestores are often paired with Lane Bryantlocations). The Catherinesbrand emphasizes the 45-and-over age group, which emphasizes age-appropriate comfort.

Meanwhile, the company exited some businesses in recent years, and of those that remain, Fashion Bug, a chain that more fashion-oriented garments to the age 30-to-50 group, is the one likely to wind up on the outside. CHRS has announced that it is exploring a sale of this unit.

On the merchandising front, every retailer occasionally misses the boat, but it seems CHRS has done that too often of late. So the new executives are changing things around, looking to make CHRS a more vertically integrated organization, meaning it will increase the percentage of its internally designed, developed and sourced merchandise, and de-emphasizing “commodity” type offerings.

Needless to say, there’s no assurance any of this will work. But I’m willing to go out on the limb here, considering that CHRS has a great target market, one that had been solidly profitable in the past, that it has been actively addressing the areas that had turned troublesome, and that the stock is modestly valued.

LJ International (JADE)
This company has long been profitable, its return on equity has been running lately at about 13%, and its trailing 12-month P/E is about 5.

In the context of the low-priced stock universe, where it’s often challenging to cover fixed costs, black ink, and a stock that can be valued based on P/E and not just price/sales or price/book, have to make us sit up and take notice.

The company is a China-based producer, wholesaler, and retailer of jewelry. Being Chinese is another thing that catches our attention, as many investors have been aggressively selling such equities, fearing that all share the same propensity for fraud as we’ve seen in a few instances.

Hence one reason why JADE’s P/E is so low. Before the onset of China-phobia, the P/E was typically in the teens, more often than not in the mid- to high-teens.

Meanwhile, JADE is one of many Chinese firms that have operated honestly. It hasn’t been perfect; it just recently decided to revise the way it accounts for costs, and took a modest charge to wholesale sales and gross income—but this is not unique even among US businesses, which have had to cope lately with especially harsh economic conditions.

In any case, signaling an intention to maintain a strong reporting discipline, the company decided last month to hire the Asian subsidiary of Deloitte Touche as its auditor.

Even so, there’s no way to predict how long the market will persist in tarring all Chinese micro caps based on the wrongful actions of a few. But as low-priced stock investors, we are often willing to be patient as home-run potential develops, and could treat the stock’s recent drop back below our $3 price ceiling as another opportunity to get aboard.

Besides offering the usual jewelry based on gold and silver, JADE specializes in the colored-jewelry segment. Having a distinct niche helps keeps it on the “A-lists” of wholesalers with which major retail channels must deal. In fact, the positions of such key distributors have become stronger given that retailers are looking to consolidate their sources of supply.

Finally, we have a growth venture here; the company’s own emerging, China-based ENZO retail-jewelry chain. It was launched in 2004, and as of mid-2011, the store count was up to 154; it is targeted to reach 180 to 200 by year-end.

These stores are being very well received in China, where the economy remains good and affordable luxury is a hot product category. Comparable-store sales gains were 24% and 61% in the first and second quarters of 2011. LJ International is a buy.

Subscribe to the Forbes Low-Priced Stock Report here…

Related Reading:

Related Articles on STOCKS