3 Well-Known Retail Stocks with at Least 50% Upside

Ryan Fuhrmann's picture

Tuesday, May 31, 2011 - 11:00am

by Ryan Fuhrmann

In early 2008, falling home prices and a declining stock market caused consumer spending to plummet. This lasted for about 18 months. But soon consumers started to realize that the economy wasn't going to remain in freefall forever. Today, the retailing industry has recovered quickly, is on much more solid footing, and certain players are set for a big move forward in terms of sales and earnings.

In 2011, higher food, fuel and commodity costs are keeping consumers focused on more basic necessities, including food, gas and clothing. But the fact that demand has recovered from the recession a couple of years ago means customers are again paying up for more fashionable and pricey merchandise. Near term, gas prices have already moderated recently, and the consumer spending climate is likely to continue to improve in the next couple of years along with the overall economy.

With that, below are three retailers that offer a decent combination of fashionable merchandise but also focus on selling products that consumers will need no matter the economic climate. Reasonable valuations combined with growth potential and a growing economy suggests big upside potential for investors within the next one to two years.

1. Kohl's
Business: Off-mall department store operator
P/E: 12.3

Like all retailers, Kohl's (NYSE: KSS) was adversely affected by the plummet in consumer spending that occurred during the credit crisis. However, sales dipped only slightly in 2008, falling less than 1% to $16.4 billion. Profits fell a more severe 14.7% to $885 million, or $2.89 per diluted share, but have come roaring back and hit $1.1 billion, or $3.65 per diluted share, in 2010. Growth should be very strong this year. Analysts project $4.39 in earnings for year-over-year growth of almost 20%.

Kohl's has it all as a retailer. Its focus on basic apparel fashion is a major reason it did well during the financial crisis. It also continues to open new stores across the United States, which now total about 1,100. It also does this profitably, with net margins of 6.1%, impressive for a retailer. Kohl's also generates strong operating cash flow that leaves enough to spend on maintaining or opening stores and plenty left over to buy back stock. The company even recently initiated a dividend, which amounts to a current yield of 1.8%. Finally, its valuation is appealingly low, with a forward price-to-earnings (P/E) multiple of 12.3.

2. Target
Business: Big-box general retailer
P/E: 11.8

Target (NYSE: TGT) also did well during the credit crisis on a sales basis, growing by 6.5% to $63.4 billion in 2008 from the previous year. A focus on general merchandise helped, but a more fashionable attitude toward its products did not. As a result, profits dipped a rather dramatic 14.1% to $2.86 per share but have come back in strong fashion, rising to almost $3 billion, or $4 per share last year. Analysts project a further recovery this year with earnings of $4.17 for modest year-over-year growth of 4.3%.

For reasons I detailed in a past article, Target's growth prospects recently perked up even further. In January, it announced ambitious growth plans in Canada and plans to open 100-150 stores in that country by 2014. Target has also acquired the leasehold interest for a total of 220 store sites that will allow it to grow the store base by more than 12%. The company also plans to grow quickly in Mexico and Latin America.

Domestically, Target is remodeling its store base to add more grocery products in order to bring customers in more often and steal market share from archrival Wal-Mart (NYSE: WMT) and local grocery store chains. At a forward P/E below 12, I see a rally of at least 50%, which is based off a P/E of 15 and $5 per share in potential earnings within three years.
 
3. Bed Bath & Beyond
Business: Kitchen and home furnishings
P/E: 15.3

 
On an earnings basis, Bed Bath & Beyond (Nasdaq: BBBY) is the most expensive of these three retailers, but it arguably has the most compelling growth prospects. This isn't due to the 1,000 or so namesake Bed Bath & Beyond stores in the United States and Canada, which focus on core kitchen and home product goods. Instead, the company's newer concepts such as buybuyBABY and Christmas Tree Shops are what could propel growth. There are currently only about 100 locations of these stores, so there is plenty of room for growth. The baby superstore market has room for another competitor, as the only large current player is Babies "R" Us. The Christmas Tree stores are similar to Bed Bath & Beyond, but more discount-oriented.

Bed Bath is incredibly well-managed, with net margins of 9% (net income of $791.3 million divided by sales of $8.8 billion in 2010) and no long term debt. Like Kohl's, it grows with funds generated by its existing store base and also buys back significant portions of its own stock. Last year, it repurchased almost $700 million of its shares.
 
Action to Take --> My money is currently on Kohl's and Target. I see a strong combination of a compelling valuation and above-average growth prospects. I see at least 50% upside in both stocks in the next two years and I think they can double in five years. I have been a shareholder of Bed Bath & Beyond in the past and would consider it after another couple of quarters of strong profit growth and proof it is focusing on its younger concepts to boost future shareholder returns.

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Ryan Fuhrmann does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of TGT, KSS in one or more of its “real money” portfolios.