Consumer Spending Continues To Grow -- It's Time To Invest In These 2 Retailers

Nick Lanyi's picture

Tuesday, August 2, 2016 - 12:30pm

by Nick Lanyi

Times are good for America's retailers.

Retail sales hit a new record of $457 billion in June and are up 2.7% for the past 12 months, up from 2.2% year over year in May. The National Retail Federation recently increased its estimate for 2016 full-year retail sales growth to 3.4% from 3.1%. That's healthy growth, especially given that inflation is practically zero. These numbers mean two things: one, U.S. employment growth is translating into greater spending power for U.S. consumers -- and they are indeed spending rather than mostly saving, and two, companies that depend on U.S. consumer spending might perform better than recently expected in the coming quarters.

Note that I'm referring here to U.S. spending and U.S. retailers. That's because in other parts of the world, retail sales aren't rising quite as much if at all. Indeed, in the UK sales suffered their biggest decline in four years in the wake of the Brexit vote to leave the European Union. So while many U.S. retailers have some foreign exposure, and that doesn't disqualify them as a potential investment, it makes sense to favor those more heavily exposed to the United States.

These stocks appear attractive now and could move considerably higher if consumer spending rises in the coming months:

Target (NYSE: TGT) is the #2 U.S. discount retailer behind only Wal-Mart, with 1,797 stores across the country and about $73 billion in annual sales. After booming in the first decade of this century, Target has treaded water over the past few years, maintaining its sales rather than growing them, as foot traffic in its stores has slowed because of the rising appeal of online shopping.

Unlike some brick-and-mortar giants, Target was slow to jump into e-commerce -- but that seems like an opportunity now, as its online sales finally are growing rapidly with room for more. The Target brand remains strong with its core middle-class family demographic -- exactly the consumers who seem to be spending more in recent months. If this trend continues, Target could enjoy better-than-expected sales in the crucial back-to-school and holiday seasons.

Like other big box retailers, Target is also looking for growth by entering urban markets with smaller stores. While the typical Target store is around 134,000 square feet, these city stores are around 20,000 square feet, on average. This year, Target has opened smaller stores in Queens and Philadelphia, among other markets. The company also is investing in remodeling stores and updating its merchandising systems, which should raise profit margins. 

At recent prices, Target trades at less than 15 times analysts' consensus earnings per share estimate for 2016 (ends January 2017) and yields 3.1%.

Under Armour (NYSE: UA) has grown exponentially by evolving from a maker of high-performance microfiber athletic gear for athletes -- particularly pro and college football players -- to a diversified sporting good company that caters to the general public. Last week, Under Armour reported its 25th straight quarter of 20% or greater sales growth. Revenue rose nearly 28% in the quarter to $1 billion -- an impressive feat for a company that had $17,000 in sales for all of 1996.

Boosted by its fast-growing footwear segment -- sales of which rose 58% to $243 million -- and its roster of high-profile sports stars, Under Armour remains on a fast-growth track. Importantly, non-U.S. sales rose 68.3% to $150 million, pointing to future strong growth as the company goes truly global in markets like China. That's not to say the company is neglecting U.S. sales. It announced that Kohl's stores will start carrying Under Armour products in 2017, and it's expanding into sportswear, a more fashion-oriented line of apparel, this fall. Under Armour has more than 200 stores around the world.

Under Armour also continues to expand its presence in the "fitness connectivity" space, which integrates apps and social media with its products -- and helps drive additional e-commerce sales. The company's Connected Fitness revenue was up almost 75% in the recent quarter, to $23.5 million. 

At recent levels, Under Armour shares trade at a P/E-to-growth-rate ratio of around 2.8. That's a fair price for a fast-growing company that still has several years of rapid growth ahead of it. Look for the stock to exceed its 52-week high of $57.50 over the next year.

Risks To Consider: Retail stocks are dependent on continued strength in consumer spending, which could be derailed by slowing economic growth, rising unemployment, higher energy prices and other factors. 

Action To Take: Buy Target below $76 and Under Armour below $42.

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Nick Lanyi does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.