Shares of retailers are approaching a bear market with the SPDR S&P Retail ETF (NYSE: XRT) off 15.5% from its August peak. The group plunged more than 3% last Tuesday on disappointing earnings from Target and a lower-than-expected outlook from Kohl’s.
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Investors are getting nervous around the potential for new tariffs to be placed on Chinese goods in January. That’s the date tariffs increase from 10% to 25% on $200 billion in goods, the president announced in September.
Investors are also worried about general economic weakness with rising rates and slowing growth threatening to end the historic bull market.
In fact, taking a closer look at the consumer paints and entirely different picture for retailers, one that may mean the group has sold off prematurely.
Optimism Abounds For Retailers, Just Don’t Ask Investors
The selloff in retailers and generally dismal sentiment by investors belies a more optimistic outlook by consumers.
Americans are as confident in the economy as they have been in decades. For the first time in more than 10 years, voters in exit polls listed something other than the economy as their biggest concern.
Voters listed health care and immigration as their top two concerns, at 43% and 23%, respectively. Just 21% of voters were more worried about the economy than another subject.
That optimism is based in an economy that continues to prove the bears wrong. The jobs picture continues to drive the economy. Unemployment dropped to 3.7% last month, the lowest since 1969, and the three-month moving average for wage growth tracked by the Atlanta Fed jumped to 3.7% in October.
If that consumer sentiment and economy strength translates to spending, it could prove to be a very jolly holiday shopping season for retailers.
Holiday sales are expected to increase almost 5% this year from 2017, according to the National Retail Foundation, well above the average of 3.9% over the last five years. Amazon, Target, and Macy’s have all announced major hiring plans, a combined 300,000 seasonal workers, to handle the additional business.
Despite weakness in some earnings, retail executives were largely positive on the economy and outlook during Q3 calls. Doug McMillon, CEO of Walmart, pointed to momentum from a “favorable economic environment,” and both chief executives at Best Buy and Target made positive comments on the consumer.
Even beyond what could be a surprisingly strong holiday season, the fears of an escalating trade war could be overblown.
The increase in January tariffs would be a major intensification and could send the economy tumbling lower. That’s not something President Trump wants as he shifts his eye to 2020 election prospects. President Trump and Chinese President Xi are scheduled to meet during the G-20 meeting in Argentina from November 30th to December 1st and could agree to some terms of cease fire.
Finding Deals In The Bargain Rack Of Retailers
Third quarter earnings have brought plenty of deals in the retailer space. Strong brand names hit by temporary factors could be ready to bounce higher on strong holiday sales and price multiples returning to long-term averages.
Target Corporation (NYSE: TGT) was having a relatively good year until this month when worries started swirling about supply chain and margin problems. The rumors were confirmed when the company reported third quarter results, missing earnings expectations by $0.03 to $1.09 per share and posting an operating margin weaker than the year-ago comparable.
Investors punished the shares but ignored some strong signals for future growth. Much of the weakness was due to inventory buildup for the holiday season and digital sales, which surged 49% from the year ago comparable.
A 23% plunge in the shares since the September high, most of it in November, moves the shares into value territory. Target trades for 13.2 times trailing earnings versus a 5-year average multiple of 17.0 times, according to Morningstar data.
The fact that profitability took a hit on faster-than-expected digital growth shouldn’t surprise investors. Sales growth often comes at a cost but still translates to stronger earnings on an absolute basis. While missing expectations, earnings were still nearly 20% higher than last year’s third quarter. Earnings are expected higher by 7% over the next four quarters and could surprise to the upside as profitability returns on stabilizing growth.
L Brands Inc (NYSE: LB) has stumbled all year but got the wakeup call when shares dropped 14% on 3Q earnings that, while beating earnings expectations, disappointed investors on margins and overall sales growth. Shares are now down 43% over the last year.
Shifting consumer tastes caught the company, specifically its Victoria’s Secret brand, off-guard and has meant weaker pricing power versus casual clothing competitors. Management has answered by considering all options including closing underperforming stores, brand sales and cutting the dividend to strengthen the balance sheet.
Despite management missteps, the company is still a leader in its brand categories with Victoria’s Secret and Bath & Body Works. Shares now trade for just 11.4 times trailing earnings versus a five-year average of 18 times -- a premium versus competitors due to its strong brand reputation. While earnings are expected 7% lower over the next four quarters, the company has beaten expectations in every quarter over the last four years and could surprise on the upside as management turnaround plans bear fruit.
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Nordstrom Inc (NYSE: JWN) reported an upbeat 3Q, beating earnings by $0.01 and raising its full-year sales guidance by $100 million. Full-year earnings guidance was increased by $0.05 per share to between $3.55 - $3.65 per share.
The relative strength versus peers was overshadowed by a surprise expense of $72 million from accidentally overcharging delinquent card accounts since 2010. The charge only affected 4% of cardholders so it shouldn’t be material to customer satisfaction though the news sent shares plunging by 14% on the day.
Nordstrom has been a standout in managing the department store environment and hasn’t suffered as badly as competitors like Macy’s. Digital sales have grown to 30% of revenue and the company’s discount brand, Nordstrom Rack, booked strong same-store sales growth of 5.8% over the last year.
Shares trade for 15.7 times trailing earnings which are expected higher by 11.7% over the next four quarters. The price multiple is a 17% discount to the five-year average of 19 times trailing and the shares pay a 2.9% yield.
Risks To Consider: Traditional retailers still face increasing pressure from Amazon and could continue to lose market share without an online strategy.
Action To Take: Take advantage of the selloff in strong retail names to position ahead of what could be a surprisingly solid holiday shopping season.