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Retail Industry Stock Outlook - March 2013

Zacks Equity Research

Retailers procure goods in large quantities directly from manufacturers or wholesalers and sell these in smaller quantities to customers through retail shops or online. As consumer spending is the key to the viability of any economy, the health of the retail industry is an important economic indicator.

As a leader in the retail business, the United States provides ample growth opportunities for all types of retail companies. The retail industry covers everything in its scope, ranging from internet catalog sales, auto dealers, convenience stores, vending machines and clothing, thus dividing retailers into numerous categories. Retailers of all sizes, including individual direct marketers or direct sellers, small- to medium-sized franchise unit owners, and large “big-box” store operators compete in the U.S.

From a growth perspective, the retail industry ranks second among all U.S. industries, and employs an enormous overall workforce. Annual sales turnover of the retail industry is more than 12% of the total trade volume of all U.S.-based businesses. Additionally, it accounts for over 11% of total employment in the country.

Recent Industry Trends

Improving Backdrop

So far this year, the broader markets have showcased signs of a better pace of recovery and have thus infused hopes of a better economic scenario going forward. Though this statement is debatable, the significant recovery in the stock market is reflected through strong gains for the broader market indices. A number of major market indices, including the Dow Jones Industrial Average, are already at new all-time highs, and the S&P 500 is not far from its 2007 peak.

Additionally, domestic economic data have mostly been encouraging since Sept 2012. Labor and housing markets, two of the key indicators of the economy, performed admirably in this period. Also, the consumer sector joined the ranks for showcasing improved data almost consistently.

According to the U.S. Census Bureau, the U.S. retail and food services sales for February climbed 1.1% from the prior month and 4.6% from February last year to $421.4 billion. The latest domestic retail sales data points to a 4th consecutive rise on a monthly basis as well as the first highest monthly rate since Sept 2012.

Sales gains for U.S. retailers in February mainly reflect an improving job market and stronger household finances that helped consumers, which helped the economy overcome higher taxes and gasoline prices.

The employment situation in the U.S. seemed to improve in February with readings for the unemployment rate coming at 7.7% from 7.9% in Jan 2013. However, the overall scenario still appears dismal as the unemployment rate has remained range bound since Sept 2012, not providing enough stimuli to boost consumer spending, which accounts for roughly 70% of U.S. economic activity.

Moreover, the Conference Board came out with its reading of the Consumer Confidence Index -- a barometer of the U.S. consumer health – on Feb 26, 2013, which fell in January and rebounded in February. The consumer Confidence Index now stands at 69.6 from 58.4 in January.

The improving trends witnessed in retail sales, consumer confidence, automotive sales and housing data, along with declining unemployment rate confirms that the U.S. economy continues to be on track for recovery, while there's still a general uncertainty on the economic front with the GDP growth remaining sluggish.

February Sales of Retailers

The key data in retail industry analysis is comparable store sales (comps), as it excludes sales at newly opened and closed stores.

Despite the recent positive domestic economic data, February remained tough for most retailers as macro-economic factors including increase in fuel and energy costs, higher payroll taxes and delays in tax refunds. coupled with unfavorable weather conditions hindered consumer spending and in turn adversely affected the growth and profitability of companies. The best performing sectors were discount and apparel stores, while the teen apparel chains put up the worst performance in the month.

Comps results for apparel retailers like Limited Brands Inc. (LTD) (up 3%), The Gap Inc. (GPS) (up 3%), Stein Mart Inc. (SMRT) (up 0.6%), and TJX Co. (TJX) (up 1%) outperformed expectations, while Ross Stores Inc. (ROST) (down 1%) was among the underperformers.

Additionally, discount store operator, Costco Wholesale Corp. (COST) came in strong posting a 6% increase in February comps, while comps at Fred's Inc. (FRED) dropped 1.5% in the month.

On the other hand, drugstore chain Rite Aid Corp. (RAD) posted a 3.6% decline in February comps. Other major underperformers in February included, teen apparel retailers Cato Corp. (CATO) (down 3%), and Buckle Inc. (BKE) (down 1.1%).

Starting February, many major retailers including Macy’s Inc. (M), Kohl’s Corp. (KSS), Nordstrom Inc. (JWN), Target Corp. (TGT), Bon Ton Stores Inc. (BONT) and Stage Stores Inc. (SSI), announced that they will no longer report monthly sales results.

Looking ahead, retailers remain optimistic for March on account of the calendar shift in the timing of the Easter holiday, which falls on Mar 31 this year (it was Apr 8 last year). Moreover, analysts remain positive on tSt. Patrick’s Day sales, which fell only two weeks in advance of Easter Sunday this year. However, retailers expect their April sales results to be affected by the shifting of Easter into March.

Trends to Rule 2013

Some of the trends that are expected to rule the retail sector this year include employing more technological solutions, incorporating customer feedback and targeting additional audiences with products and services.

With the growth of the .com era, shoppers have largely adopted to new purchasing modes, using the Internet, mobile phones and tablets. Consumers today prefer to use their laptops or smart phones to compare prices of things they want to buy and place orders online, instead of visiting the company’s stores. This growing trend has guided major U.S. retail chains to downsize their physical retail operations, and in turn, develop their e-Commerce and m-Commerce sites to attract customers.

One such major player which has adapted to this trend is Macy’s, which continues to exhibit tremendous online growth momentum. The company registered online sales growth of 47.7% in the fourth quarter and seeks to further expand its online portal going forward.

Another brick-and-mortar chain that is aggressively adapting to new realities and strengthening its online presence is Nordstrom Inc. In addition to offering free shipping and free returns in its online store, the company has introduced a new functionality of mobile point-of-sale devices and continues to expand its usage in full-line and Rack stores.

Further, Nordstrom is expanding its online merchandise selection and developing a more customized approach to enhance the overall web and mobile experience. The company expects to spend 25% of its planned five-year capital expenditures towards e-Commerce and technology investments, including initiatives to improve e-Commerce delivery and fulfillment, online and mobile experience and personalization.

Other traits that are expected to affect the retail industry are the growth of self-service options for processes such as checking out and finding items in stores. These offerings provide greater convenience and faster transactions, and they satisfy shoppers who prefer to visit brick-and-mortar locations for immediately purchasing predetermined items.

The "Re" in Retailing

"Transformation" is the new mantra among retailers. Despite rapid technological advancements which are influencing consumer behavior, the retail industry continues to reinvent, redesign and revitalize its physical store formats to maintain their dominance.

Of late, retail giants including Best Buy Co. Inc. (BBY), Target, JC Penney Co. Inc. (JCP) and Build-A-Bear Workshop Inc. (BBW) are focused on revisiting and re-evaluating conventionality and traditional business traits, while envisioning its brick-and-mortar store merchandise offerings. Additionally, these companies continue to actively re-engineer and re-tool various systems and processes.

Retail groups are coming up with strategic initiatives to boost operating efficiencies, drive growth and enhance shareholder value. Most of the retailers are focusing on drastically abridging costs to ensure competent operating channels. We believe that such measures are necessary to gain competitive advantage over peers. However, a focus on improving the top line should be prioritized to accelerate long-term growth.

The above-mentioned traits are made clear seeking the example of JC Penney, which has left no stones unturned to bring the company back on the growth trajectory. Management has taken up several initiatives -- from implementation of a new pricing strategy, refreshed logo, strategic merchandise and cost reduction -- while enhancing the shopping experience of customers. The company targets expenses to be 27% of sales by the end of the transformation process.

Moreover, the leading specialty retailer of consumer electronic products, Best Buy, shuttered stores which did not contribute to its growth, while modifications of others are also in the cards. The company plans to transform its big-box format to a big profit center by redesigning its prototype stores to resemble Apple Inc’s (AAPL) retail store format. Best Buy is not the first one to resort to such mimicry, as Microsoft Corp. (MSFT), Walt Disney Co. (DIS), Tesla Motors Inc. (TSLA) and AT&T Inc. (T) have already opened stores imitating the Apple format.

Target Corp. is another retail chain that has resorted to a major remodeling program called ‘P-fresh.’ This program aims at sustaining sales at existing general merchandise locations by adding perishable food items, along with a deeper assortment of dry dairy and frozen items, and improved store layout and enhancement of in-store shopping experience across departments, such as apparel, home, beauty, shoes and baby. During fiscal 2013, Target plans to remodel 100 locations.

Hot Topic Inc. (HOTT) -- a leading shopping mall-based specialty retailer -- unveiled its new ‘Blackheart’ store concept, offering intimate apparel for women between the ages of 18 to 30. These stores are positioned in North America over competitor Limited Brands’ La Senza stores, which operate only in Canada and has international sites.

Challenges and Some Remedial Measures

The retail industry is highly competitive and encounters significant challenges. Although the U.S. economy has started witnessing a recovery, we still believe that 2013 will not fully mark the return of the retail market. Consumers are slowly regaining confidence and cautiously increasing their spending.

Moreover, consumers remain sensitive to macro-economic factors including interest rate hikes, increase in fuel and energy costs, credit availability, unemployment levels and high household debt levels, which may negatively impact their discretionary spending, and in turn, adversely affect the growth and profitability of retail companies.

Macroeconomic Conditions: Retail is no different from other U.S. industries, which is highly dependent on the economy to prosper. Such heightened dependence on the economy and factors like job growth and interest rates indicate that a speedy recovery of the economy is vital for the health of the retail industry. While the unemployment rate has decreased considerably over time, consumers are now beginning to draw out their savings to spend, anticipating some economic recovery.

Though this is a positive sign, there has been a considerable rise in prices of commodities, which is making it difficult for consumers to make ends meet. On the other hand, retailers are struggling as they are unable to pass these increased costs to consumers and their employees, given already-shrinking income levels.

Changes in Consumer Needs, Attitudes and Behavior: The growth of modern retail is linked to consumer needs, attitudes and behavior. Adapting to the sluggish economic environment prevalent over the last few years, consumer behavior has shifted to being more conservative. This has now become the regular behavioral pattern of consumers as they remain budget conscious, seeking greater value. In the process, buyers are swiftly switching to the less expensive brands and consolidating shopping trips.

Moreover, people today prefer to cook at home instead of eat out. This shift in consumer behavior is inducing retailers to adopt various strategies to stay in the competition. Retailers are offering trend-right and well-designed assortments at compelling prices, without compromising on the quality, in order to drive traffic.

Higher Fuel Prices: As a new trend noticed of late, shoppers are making fewer shopping trips. This has emerged from the rise in gas prices as well as the hectic lives of consumers, while incomes are restricted. Looking ahead, we expect this trend to continue for the next few years.

Apart from cutting down on the number of trips, shoppers chalk out their shopping agenda before stepping out. Today, consumers look for multichannel retail outlets, which offer a variety of goods, rather than making separate visits for paper goods, health and beauty items, groceries, etc. Retailers now need to understand consumers’ shopping patterns and get the most out of their visits by broadening their assortments with the appropriate depth, breadth and freshness to appeal to shoppers’ tastes.

Staging Stores: The waning popularity of brick-and-mortar store formats has made it essential for retailers to adopt new techniques like ‘staging stores’ to woo customers. Staging basically refers to the act of making the company’s stores attractive, where people like to spend their time. One example of this is Starbucks Corp. (SBUX). The idea behind this strategy is to make shopping interesting for consumers, so that they would want to walk into the stores, rather than shop online.

Use of Internet and Mobiles in Shopping: With shoppers becoming more and more tech-savvy these days, a new era of shopping via Internet, smartphones and tablets has taken over. Today, consumers are increasingly using the tech-media to make purchases, find coupons and search for the best deals. This has affected the business of the traditional brick-and-mortar stores, inducing retailers to shutter underperforming stores and directing resources to build the e-Commerce platform.

The rate of electronic retail shopping is expected to increase significantly over the next 4 to 5 years. To take advantage of this growing trend, retailers need to identify the best possible means of benefiting from the use of technology in shopping while implementing relevant strategies. By integrating the digital mode into the shopping experience, retailers can earn rewards in the form of increased shopper demand and greater shopper loyalty.


Retailers are trying to remain competitive primarily by shifting focus to the long-term horizon and finding innovative solutions to create value, reduce operating costs and mitigate risks throughout the enterprise.

Right-sizing inventories, enhancing efficiency and competence and bringing in technological advancements are the key agendas that retailers are focusing on. Moreover, cost-containment efforts and merchandise initiatives to improve margins are top priorities.

Retail, owing to its huge spectrum, remains a lucrative investment avenue for investors. The sector reflects consumer spending trends, an important parameter to gauge the health of the economy (consumer spending accounts for approximately 2/3rd of the economy). Thus, identifying future winners from this sector would be a good investment decision.

We recommend few stocks in the sector at this point, as these companies are showing significant growth despite the secular headwinds. Adaptability to the buying habits of the consumers and strengthening the loyalty base helped these retailers post strong results. The stocks in our coverage with a Zacks Rank #1 (Strong Buy) include Sears Holdings Corp. (SHLD), Macy’s Inc. (M), Big 5 Sporting Goods Corp. (BGFV), Rite Aid Corp. (RAD), Whirlpool Corp. (WHR) and Safeway Inc. (SWY).

Additionally, we prefer stocks with a Zacks Rank #2 (Buy), namely Hot Topic Inc. (HOTT), Bed Bath & Beyond Inc. (BBBY), Zumiez Inc. (ZUMZ), SUPERVALU Inc. (SVU), Cabela’s Inc. (CAB), Kroger Company (KR), Avon Products Inc. (AVP), Ralph Lauren Corporation (RL), PVH Corp. (PVH) and Guess Inc. (GES).

On the other hand, retailers to avoid with a Zacks Rank #5 (Strong Sell) include JC Penney (JCP), Aeropostale Inc. (ARO) and ANN Inc. (ANN). Retailers on our Zacks Rank #4 (Sell) list include American Eagle Outfitters Inc. (AEO), Pacific Sunwear of California Inc. (PSUN) and Staples Inc. (SPLS).

Read the analyst report on LTD

Read the analyst report on GPS

Read the analyst report on SMRT

Read the analyst report on TJX

Read the analyst report on ROST

Read the analyst report on COST

Read the analyst report on FRED

Read the analyst report on RAD

Read the analyst report on CATO

Read the analyst report on BKE

Read the analyst report on M

Read the analyst report on KSS

Read the analyst report on JWN

Read the analyst report on TGT

Read the analyst report on BONT

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