As I prepare to get locked and loaded on retail, a favorite sector of mine to study, let's take a minute to bring you inside the inner analytical circle. Chances are you have awoken to an overwhelming amount of news on December same-store sales from retailers, as well as fourth-quarter guidance -- and a further hammering-home of the trends that materialized during the holiday season.
There is nothing wrong with picking apart the barrage of press releases. Of course, in the process, be sure to assign equal weight to management comments -- on merchandise margin, inventory levels, post-holiday trends and online sales -- as you do to the actual sales and flow through to the bottom line. That is, pay attention to earnings after accounting for costs, expenses, interest and taxes.
Still, I want to think in a manner that's a touch more granular -- because that's how the top-ranked Wall Street analysts, and their penny-loafer-wearing 20-something associates, go about their business. Without further ado, here is the Sozzi retail-investing attack plan.
Messages the Market Is Sending
Lower-quality names in the retail sector have outperformed higher-quality ones in the past 13 weeks. I put Aeropostale (ARO), Pacific Sunwear (PSUN), Gap (GPS) and J.C. Penney (JCP) in the subpar-quality camp. On the other end of the spectrum, meanwhile, lie Limited Brands (LTD), Costco (COST), Nordstrom (JWN) and Abercrombie & Fitch (ANF). In regard to Abercrombie, I'm aware of the gap in the chart, which came due to a mismanagement of Street expectations -- but, fact is, the company is a globally proven leader and has trimmed underperforming stores from its domestic base at an impressive clip.
In any case, the rising tide that is the U.S. economy will indeed lift the badly battered boats, as higher traffic in shopping malls tends to benefit stores that are not solely top-of-mind. However, consumer spending is likely to moderate in the first quarter. So, even though the market may not be too keen on paying up for higher earnings growth stories at the moment, that spending retreat should make for a rotation back into quality names.
In short, you should be placing companies with tattered balance sheets, exposed liquidity shortfalls or zero pricing power on the "Go Short" or "Avoid Like the Plague" lists. Even tamer cotton costs and online momentum won't be enough to save the day.
Investors have particularly fallen in love with off-price retailers Ross Stores (ROST) and TJX Cos. (TJX), but the valuation here is a little less compelling than what I would like to see in front of some fundamental trend changes. For starters, in a cooler environment for costs and tempered maneuverability on price hikes, the mall should be a prime destination once again for consumers. That's not good for these stand-alone stores.
Second, 2012 will be the year of retail mobility, from the onset of mobile checkout while one waits in line to significantly revamped apps on Apple (AAPL) iPhones and Google (GOOG) Androids. Ross Stores and TJX do not sell products online and, in fact, it sounds as if the latter won't doing so until well into the future. That means investors are being asked to navigate away from a very large trend that is upending how the industry operates.
Three, for retail, 2011 was characterized by investments in inventory-planning technology (Macy's (M), in particular, has become quite good at tailoring product by geographic zone.) I don't really recall hearing about any unit-inventory blowups by retailers throughout the year, as year-over-year gains reflected product inflation, and not necessarily units. These trends should continue in 2012. TJX and Ross Stores buy excess goods, and if there are fewer quantities of these to land at attractive prices, that would be a potential red flag.
Messages Consumers Are Sending
• We will spend more this year than we'd planned to do, but without any month-to-month consistency.
• We are open to using credit cards and splurging on anything that's unique and useful.
• We are starting to bite on special Facebook and Twitter promotions, even though we won't admit it.
First Quarter 2012 Items to Watch
• Flat inventory unit growth should be viewed favorably. I continue to favor conservative planning to support merchandise margin expansion vs. a blind-luck call on having inventory to support an acceleration in same-store sales. The macro picture could turn on a dime, as we learned this past summer.
• Pay attention to those retailers that come out aggressively on share repurchases and stock buybacks, of which there will be a few. Management teams will be attempting to differentiate the stock's return profile in this yield-favored investing climate.
• Look for any indication of stabilization in demand trends in key European markets. Of course, I admit this may be wishful thinking. Still, if we are able to decipher that a bottom has been achieved, names such as Tiffany (TIF) and Guess (GES) will be where to focus after the shares' second-half swoons in 2011.
• China economic data has clearly decelerated, yet every retailer went gangbusters in terms of expansion in the country in 2011. Coach (COH) is a good example of a retailer that has been hyping its China growth story, so any headwinds that arise should constrain the stock's multiple.
• Insight on lower input costs, specifically in cotton, have to be heard. If any company has negative things to offer on this topic, that'll be a red flag.
Where I Am Focused
My primary selection screen focuses on those companies that managed to beat the Street's expectations on sales, margin, and earnings per share in 2011, despite the year's inflationary-cost backdrop and volatile spending trends. My recent bullish call on Macy's encompasses these factors -- as well as the store's superior online revenue growth, the potential for an eye-catching share-repurchase plan this year and a lifted dividend.
Lululemon (LULU): This is a high-multiple name that has given up a fair amount of ground since July, and now sports a valuation that is more reasonable to go alongside attractive long-term growth characteristics. I believe the brand is continuing to grow in popularity due to management's grassroots marketing efforts. The downside to the positive thesis rests with the over-indebted Canadian consumer, and how that will impact Lululemon's store performance in the region.
Foot Locker (FL): The company should command the attention of investors given the stock's yield, relative valuation and streamlined operations. That's in addition to the company's attachment to Nike's (NKE) strong product innovation and rising price points.