The Daily Dose: Put Retailers to the Test

 | Aug 20, 2014 | 11:00 AM EDT  | Comments
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"Retailers had the biggest advance today among 24 groups in the S&P 500, climbing 2.2 percent," proclaimed Bloomberg on Tuesday. I know you missed that statement amid all of the traffic-driving linkups now being found in zillions of online stories. But what you likely didn't miss were Wall Street analysts coming out with post-earnings notes sounding rather bullish on retail stocks for arguably the first time this year.

I have been watching this unfold for the past week or so, and I suspect it will continue after the latest round of earnings from Home Depot (HD), TJX (TJX), and Dick's Sporting Goods (DKS) (not Target (TGT) today, however).

A few things are behind this budding bullish tone on the Street:

Back-to-school sales surged in the final week of July, and the general consensus among exec teams is that demand has continued to be solid in the first weeks of August. Although Home Depot is not a back-to-school name, its management noted on its earnings call that it was "very pleased" with sales in August. If Home Depot is doing well to begin the third quarter, imagine the bounce-back in same-store sales for many apparel retailers as parents restock their kids' closets and backpacks.

Online sales growth rates have been downright impressive for just about every single retailer, and online is becoming a much larger portion of companies' total sales. This is important to finally see, as companies have been investing massive dollars in the past two years to support new online initiatives, such as "buy online and pick up in store" and "buy online, reserve in store."

Back-to-school is always used as an indicator on the holiday season. So to have TJX and Home Depot raise their outlooks, while J.C. Penney still enjoys a period of sales recovery, suggests happy tidings for retailers' registers in November and December. Happy tidings then mean clean inventories when these retailers enter first-quarter 2015 earnings calls, and upbeat initial full-year outlooks. Yes, believe it or not, real investors are buying in anticipation of that.

That said, I am not telling investors to gobble up shares of retailers hand over fist. Rather, some key qualifiers have to be satisfied before I put my rep on the line. Here is what I am stressing in terms of fundamentals:

I want to see consistently positive two-year same-store sales stacks. If a company posted a 5% same-store sales increase in the second quarter of 2013, I want to see it post at least a 3% same-store sales gain in the second quarter of 2014. At the bare minimum, the figure has to be positive. A solid example is Home Depot, which reported a +6.4% U.S. comp in the second quarter of 2014, compared with +11.4% in the year-earlier quarter. That consistency indicates true momentum in the business.

There has to be leverage over operating expenses. If a company records sales growth, expenses have to have increased by a slower rate. I view this as strong management execution, to bring in more sales, invest in the business and yet deliver earnings that beat consensus forecasts.

Online, online, online -- the sales have to be increasing by double-digit percentages quarter upon quarter. There is no excuse for sales not to be increasing at such a clip, as more mobile devices with large screens and apps lend themselves to higher amounts of digital consumption. Home Depot's online sales were up a cool 38% in the quarter, after a 40% increase in the first quarter of 2014. The online channel now represents 4% of total company sales. About 10% of the company's online sales are being derived from inside the store.

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