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Retail-Discount Stores Industry Outlook: Margin Woes to Nag

Sumit Singh

The Zacks Retail – Discount Stores industry comprises companies that offer apparel, accessories, footwear, beauty products, personal and baby care products, cleaning products, pet supplies, and food and beverage products. The industry participants also provide home textiles, home furnishings, housewares, toys and seasonal décor products. These companies sell their products either through stores or digital channels or both. Some of the industry players operate membership shopping warehouse clubs offering branded and private-label products in a range of merchandise categories. Some of the prominent names in the industry are Dollar Tree, Inc. (DLTR), Dollar General Corporation (DG) and The TJX Companies, Inc. (TJX).

Let’s take a look at the industry’s three major themes:

  • The industry’s prospects are correlated with the purchasing power of consumers. Apparently, strengthening labor market and rising disposable income have been fueling consumers’ spending activity. The strategy to sell products at discounted prices has helped industry players expand customer base, which comprises low to middle income groups. Moreover, a differentiated product range in sync with customers’ spending habits enables the companies to enrich the shopping experience, resulting in market share gains and higher sales per square foot.
     
  • The industry players are steadily developing omni-channel capabilities, which include technological updates and store remodels. They are undertaking brand enhancement efforts with off-price models and innovative customer-friendly approach such as same-day delivery options to make the most of the upcoming holiday season. These endeavors along with a compelling store growth story at convenient locations and focus on demand-driven products are driving the industry participants. Better pricing, effective inventory management, and merchandise and operational initiatives should boost revenues of the industry constituents in the festive period.
     
  • The companies in the industry are vying for a bigger share on attributes such as price, products and speed to market. Further, the increasing dominance of Amazon (AMZN) has made the retail-discount space highly competitive. This has compelled a number of players to strengthen their digital ecosystem and boost shipping and delivery capabilities. While these endeavors drive sales, they entail high costs. Apart from these, any deleverage in SG&A rate, higher labor and occupancy costs, and increased marketing and other store-related expenses might also put pressure on margins. Nonetheless, companies are resorting to cost containment. Again, imposition of trade tariffs due to the U.S.-China trade war might affect near-term results of some companies in this industry.

Zacks Industry Rank Indicates Dull Prospects

The Zacks Retail – Discount Stores industry is housed within the broader Zacks Retail – Wholesale sector. The industry currently carries a Zacks Industry Rank #160, which places it in the bottom 37% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates gloomy near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. Since December 2019, the industry’s earnings estimate for 2020 has decreased approximately 3.1%.

Despite the industry’s bleak near-term prospects, we will present a few stocks that one can buy or hold on to. But it’s worth taking a look at the industry’s shareholder returns and current valuation first.

Industry vs. Broader Market

The Zacks Retail – Discount Stores industry has outperformed both the broader Retail – Wholesale Sector and the Zacks S&P 500 composite over the past year.

Stocks in this industry have collectively advanced 38.7% compared with the Zacks S&P 500 Composite’s increase of 18.7% and the Zacks Retail – Wholesale sector’s gain of 16.3% in the said time frame.

One-Year Price Performance




Industry’s Current Valuation

On the basis of forward 12-month price-to-earnings (P/E) ratio, which is commonly used for valuing retail stocks, the industry is currently trading at 24.49 compared with the S&P 500’s 19.09 and the sector’s 25.78.

Over the last five years, the industry has traded as high as 24.49X and as low as 17.95X, with median being at 20.07X, as the chart below shows.

Price-to-Earnings Ratio (Past 5 Years)



Bottom Line

Discount retailers have successfully created a niche despite the rising popularity of online retailers that has impacted many traditional operators. They are primarily thriving on investments, focus on cost savings and introduction of loyalty and marketing programs. However, costs associated with promotional activities and an aggressive pricing strategy on account of stiff competition are major deterrents.

That said, we are presenting four stocks from the Retail – Discount Stores industry, which are well positioned to capitalize on the opportunities. Of these four stocks, first two carry a Zacks Rank #2 (Buy) and the remaining two carry Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Costco Wholesale Corporation (COST): For this operator of membership warehouses, the consensus EPS estimate for the current fiscal year has risen by 4 cents over the past 30 days. Moreover, the company has a trailing four-quarter positive earnings surprise of 7.8%, on average. The stock, which has gained roughly 44% in the year, has an estimated long-term earnings growth rate of 8.%.

Price and Consensus: COST




Burlington Stores, Inc. (BURL): Shares of this retailer of branded apparel products have surged about 44% in a year. The Zacks Consensus Estimate for the company’s current-fiscal EPS has increased by 5 cents in the past 30 days. The company has a trailing four-quarter positive earnings surprise of 7.6%, on average.

Price and Consensus: BURL



Target Corporation (TGT): Shares of this general merchandise retailer have gained approximately 57% in a year. The Zacks Consensus Estimate for the company’s current-fiscal EPS has been stable in the past 30 days. The company has an estimated long-term earnings growth rate of 7.5%. The company has a trailing four-quarter positive earnings surprise of 8.6%, on average.

Price and Consensus: TGT



Ross Stores, Inc. (ROST): For this operator of off-price retail apparel and home fashion stores, the consensus EPS estimate for the current fiscal year has been stable over the past 30 days. Moreover, the company has a trailing four-quarter positive earnings surprise of 3.8%, on average. The stock, which has rallied roughly 29% in a year, has an estimated long-term earnings growth rate of 10.5%.

Price and Consensus: ROST



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