1.29.14: The Detail of Retail: Be Selective but Don’t Abandon the Sector

No question, retail stocks have taken a total beating since late November, early December with a multitude of reasons for the decline.  The sector is as now oversold as it has been in the last few years:

1.) Bad weather has strangled the Midwest, at least that is the case in Chicago, where the snow started early December this year and the Polar Vortex has resulted in some of the coldest weather of the last century. If it isn’t the cold, it is the snow and the wind, which has made travel tough in places like Chicago, which is typically a pretty hardy city. With Superstorm’s Sandy and Nemo on the East Coast last year, and the Midwest winter this year, this is the 2nd year in a row retailers have gotten beaten down thanks to Mother Nature.

2.) Ecommerce: even my clients in the wine business, which is typically a hands-on, taste and feel business, talk of wine retailers building an ecommerce presence. The percentage of ecommerce as a total of retail sales continues to grow, It isn’t going away, but neither are bricks-and-mortar.

3.) Inflation, or lack thereof: I really think the 1.5% annual PCE (personal consumption expenditure) deflator, a favorite inflation measure of the Fed, is pressuring retailers. A 1.5% annual inflation rate makes it very hard to grow margins and NOT squeeze suppliers You would have to think that such a low inflation rate ripples all the way through a retailer’s supply chain. The disinflation or deflation still being experienced by the US economy has to be a concern for the Fed, and one reason the Fed has been reluctant to initiate tapering. Simply put, without inflation, there is just no “cost” to zero interest rates;

Our high risk pick of the sector is JCP: nearing its October ’13 lows of $6.24 to $6.27, we aren’t going to give up in JCP yet. We bought JCP for the first time ever last fall, after the secondary, and will wait for either the March ’14 earnings report or the stock to trade below $6.24 on heavy volume. There are two key metrics we are looking for: we want JCP to turn operating cash-flow (OCF) positive for the holiday quarter, and sustain that positive positive cash-flow, and we want to how how jcpenney.com performs over the holidays. JCP’s ecommerce arm was a bright spot in 2013, so let’s see how it did over the holidays. This stock is high-risk for sure. Use $6.15 for your stop-loss.

Whole Foods (WFM): we still think it is a secular growth story, although they guided to slower revenue growth and 5% comp’s for fiscal ’14 during their November ’13 conference call. With Starbuck’s earnings report last week and their 5% global comp’s we think there is a good chance that WFM will be inline to slightly better in terms of comp’s when they report in February ’14, since WFM and SBUX comp’s correlate so closely. John Mackey and his team have always been very good operators. WFM has always been able to balance the “price vs value” proposition. We’ve been buying WFM in the low $50’s, with a technical gap right around $49.50 – $50.

Wal-Mart (WMT): our old standby, $70.50 is the March,2000 high for WMT and our stop-loss if needed, but an amazing stat about WMT that very few people realize is that in the 4th calendar quarter of 2008, when SP 500 earnings fell 35%, WMT never reported a negative quarter of revenue growth. The revenue growth for the Oct ’08 quarter was 7%, and for the January ’09 quarter, fell to 2%: that is simply amazing for a company nearing $500 billion in annual revenues. WMT’s ability to adjust on the fly and manage their supply chain is simply amazing, and today’s consumer environment is nothing near as serious as late 2008. WMT reports earnings in the next few weeks, usually by mid-February, and US comp’s will be the key. I do think WMT more than any other retailer is feeling the continued disinflation and deflation in the US economy. This is a very tough environment for a retailer the size of WMT to generate price increases, which would then allow their supply chain some breathing room. This has to be an even tougher environment for WMT’s supply-chain since the retailer has to be leaning on suppliers even more aggressively to just sustain margins and fulfill the EDLP (every day low price) mantra.

Coach (COH): Look for a test of the February ’13 low of $45.87. I hope the stock gets there. It is very oversold and washed out now. On the longer charts, below $53 – $55 isn’t a good place to be for the stock, but if we can catch another trade near $45, the stock would be compelling. We haven’t update dour numbers from the Jan ’14 earnings report, but will do so shortly. A trade below $45 on heavy volume and the stock is likely broken. We are not long yet, but will consider a trade near the earlier-referenced lows.

WMT and COST are the lower risk retailers. WFM, SBUX are phenomenal operators and true growth stocks where readers usually only get lower-risk opportunities to buy once every few years. We think WFM is nearing its lower-risk buy point. JCP is the higher-risk retailer in the group. The mass merchandise retailers like Dillard’s, Nordstrom’s, JCP, Macy’s and such are the higher risk retail play over the long-term as niche players and ecommerce chip away at their business model.

We have been nibbling away at JCP, and WFM the last week. JCP is a long-shot. WFM is at longer-term support.

One thing we haven’t talked about is consumer sentiment.  One of our clients described it perfectly at our recent annual client review meeting: the client is in a discretionary consumer business and noted that each time it seems like the US consumer is about to hit a 2nd level of confidence around their spending, something on a macro basis causes them to pull back. The consumer is not nearly as aggressive as they were in the late 1990’s, and haven’t hit that “next gear” that you would expect and we have seen in previous US recoveries. The US consumer remains tentative…

These opinions can change anytime, but this is now we are playing retail currently, with an eye for a longer-term trade through calendar 2014.

Thanks for reading. Hope this helps your investing thought process.

Trinity Asset Management, Inc. by:

Brian Gilmartin, CFA

Portfolio manager

brianglm@trinityasset.com

 

 

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