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Retail Stocks on the Rack

In the current crazy retail world, rummaging through racks of discount clothes at Burlington Coat Factory trumps buying Victoria’s Secret bras, and Walmart is beating Target with … groceries.

Given consumer spending is increasing at its highest rate since last fall, you’d think all retailers would be doing at least fairly well. Instead, the Internet and a surplus of sales have made shoppers finicky, and retailers must be wise enough to alter their pricing and product selection to prosper from higher consumer spending.

Look no further than the Vanguard Consumer Discretionary exchange-traded fund to see the Wild West of retailing: Year-to-date performance ranges from a gain of 56% for Burlington to a loss of 29% for Limited Brands.

Investors are rightly flummoxed by the divergence in stocks, the fortunes of which should be tied to the same economic force of consumer spending. It used to be that if consumer spending was increasing investors would be safe blindly buying a basket of retail stocks. But seismic shifts in online spending are upending all the old rules. Investors looking for great retail stocks must be sharp shooters.

The concept that wage and salary gains married with lower gas and commodity prices encourage spending is well documented. So far this year, wages are up roughly 5% and have been growing steadily for the past 12 months. Gas prices this summer should average $2.25 per gallon, 20% less than last year. The U.S. Department of Agriculture estimates that food inflation, which ran over 1% for all of last year, has dropped to roughly half a percent. An extra $20 or $30 saved per month may not move the needle much for one person’s spending patterns, but collectively each bit of incremental spending is good news for retailers.

Government data for consumer spending illustrates Americans’ willingness to spend. Personal consumption adjusted for inflation is up almost 3% for the past three months, the best growth rate since last September.

Yet companies that operate in the same retail sector are posting polar-opposite results.

Walmart surprised investors in mid-May with its seventh consecutive quarter of positive comp sales and offered strong guidance for the second quarter. Yet Target, a retail chain often considered a more adept operator, clobbered investors with lower-than-expected revenue and the news that demand weakened as the quarter progressed.

What gives? Both retailers are considered discount chains and house their stores in large shopping centers rather than in malls. Apparel, a notoriously tricky product to sell, is partly to blame. Clothing has seen its share of online purchases increase dramatically. Not only does this decrease the amount of clothing bought in stores, it allows consumers to shop for the lowest price without ever leaving their homes. Target for example, relies more heavily on apparel sales than Walmart, which has shifted more of its sales to grocery items.

Companies successfully navigating the apparel minefield are either offering a treasure hunt experience or are being heroically disciplined about discounts. Burlington Stores, the 56% gainer we mention above, derives 83% of its sales from clothing and accessories but is seeing 8% growth in sales. This store, like retail winner T.J. Maxx, offers customers the experience of digging through racks for name brands on sale.

L Brands, the big loser, is suffering a double whammy of lower foot traffic in malls and a shift away from its super-sexy Victoria Secret’s bras. The company hasn’t been quick enough to alter its product mix.

Just like the consumers flipping through the racks at stores, investors can find bargains in the retail sector. Many stocks that were sold off due to consumer-spending fears can be bought at cheap prices. We’ve been doing the heavy lifting and have a handful of specially picked retailers in our Profit Catalyst and Growth Stock Strategist portfolios.

 


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