3 Ways to Play Retail into Back-to-School Season

 | Jul 18, 2016 | 10:00 AM EDT
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By all outward indications, the heads of U.S. households are poised to step up nicely, starting later this month and into August, for their children's back to school needs. Although the latest read on consumer confidence was mixed, the June retail sales report was highly encouraging. With savings rates continuing to be elevated, it may be that consumers are finally OK with dipping into those savings, and living life a little more lavishly. Even the recent consumer credit report for May was upbeat, as were the loan demand trends in earnings reports from banks such as Wells Fargo WFC and JP Morgan JPM.

According to eMarketer, U.S. retail back-to-school season sales are expected to rise 2.6% from the previous year - to $828.8 billion. If achieved, it would mark an improvement from the 1.6% sales increase notched in 2015. As it stands now, this type of tepid growth forecast -- which many analysts are basing their ratings and third quarter earnings estimates on -- are helping to keep expectations low on retail names. That's a good thing.

Here are a few ways to play the potential buying binge:

1. Walmart (WMT) . The stock has been one of the hottest names in retail, unsurprisingly. I think the market has wagered on a few things from the world's largest retailer:

  1. no more wage increases for employees this year or in 2017;
  2. a more aggressive retailer, in trying to compete online with Growth Seeker holding Amazon (AMZN) ;
  3. benefit from product deflation; and
  4. investment in lower prices luring in more traffic from the likes of Target (TGT)  (a holding of 

Sticking with Walmart through the back-to-school season is a bet that parents are buying a few extra outfits for their kids, and are also putting a few more upscale food items in their lunch baskets. Additionally, I think Walmart will be the destination for school supplies - despite Staples' (SPLS) stepped up efforts to make pricing more competitive for essentials, such as notebooks, pens and paper (I wasn't convinced on the company's plan when sitting across from the head of North America business two weeks ago).

2. Abercrombie & Fitch (ANF) . Shares of the preppy apparel retailer have been hammered since early May, when the company's soft first-quarter earnings results sparked concerns that its turnaround had hit a snag. Moreover, the company's high exposure to Europe has left investors concerned on the near-term demand outlook.

While I respect all of that thinking, the market may be now overlooking how far the company has come on shedding underperforming U.S. stores, its willingness to potentially exit certain European flagships in 2017 to improve the bottom line and the vastly improved merchandise aesthetic (and from my recent checks, relatively clean inventory levels). As I have said for over a year, American Eagle is the more dependable pick in teen apparel. But a 30% plunge in Abercrombie's shares has greatly improved the risk/reward profile.

3. Urban Outfitters (URBN) . Short this dog. I have been out touring a good number of the company's store over the past month. Sure, it's weird for a young male to walk around an Anthropologie store all alone, but hey, I have a job to do. I think the company is sitting on an ugly second quarter amid sluggish demand for its absurdly expensive clothing that could be bought 50% cheaper at Zara and Forever 21.

The busiest parts of the store, from what I have seen, are the large number of sales racks at all three of the company's store concepts. As for back to school, the company will be hard pressed to wrestle kids away from affordable fast fashion houses, a resurgent Abercrombie and a rock-solid American Eagle Outfitters. And if the company disappoints for back to school -- like I think it will -- the market will swiftly punish the stock on fear of a lackluster holiday season.

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