Dependent On The Consumer

3/4/2013


The consumer-discretionary sector — a disparate group encompassing everything from specialty retailers to casinos to homebuilders — has ranked among the five top-returning S&P 1500 Index sectors in each of the past five years. Up 6% so far in 2013, the sector has slightly outpaced the broader index.

Since 2008, the consumer-discretionary sector has returned an annualized 10.3%, more than triple the broad index and the highest of any sector. Yet the stocks aren't especially expensive. The average consumer-discretionary stock trades at 19 times expected year-ahead earnings, slightly below the average for stocks in the broad index. More to the point, we see a number of attractively valued consumer names with solid growth potential.

An array of retailers preparing to report January-quarter results in coming weeks will test the sector's growth story. Surveys suggest mall traffic was light in February. And retail bellwether Wal-Mart Stores ($71; WMT) sounded the alarm that delays in income-tax returns have pressured February sales, especially for big-ticket items. That could push more sales into March and April.

Slow wage growth, coupled with the termination of the payroll-tax break, could weigh on discretionary spending throughout 2013. Making matters worse, gasoline prices are about 2% higher than a year ago after a $0.49-per-gallon — or 15% — rise since Jan. 1. The Energy Information Administration estimates about two-thirds of the rise in price stems from higher crack spreads, or the difference between the wholesale price of gasoline and the price of crude oil. While the EIA says crack spreads are starting to narrow, it acknowledges pump prices may not yet fully reflect high wholesale prices.

INDUSTRY COMPARISON
Steep one-year run-ups have stretched valutions in some consumer-discretionary industries within the S&P 1500 Index. But pockets with both solid growth outlooks and attractive valuations still exist. Below we present industry averages, excluding groups with fewer than five companies.
Performance
--- Valuation ---
Est.
Year-
To-Year
EPS Chg.,
Next
6 Mos.
(%)
90-Day
Chg. In
EPS
Est.
For Next
6 Mos.
(%)
S&P 1500 Industry
(No. Of Companies)
YTD
Total
Retun
(%)
1-Yr.
Total
Return
(%)
Price/
Earnings
Price/
Sales
Price/
Oper.
Cash
Flow
Quadrix
Overall
Score
Apparel Retail (23)
(2)
12
16.1
0.9
8.5
15
(8)
73
Apparel & Luxury
Goods (17)
8
13
18.8
1.4
13.3
21
(6)
59
Auto Parts &
Equipment (7)
5
1
17.5
0.9
10.6
(1)
(4)
69
Broadcasting &
Cable TV (8)
(1)
18
17.2
2.1
8.8
10
(4)
70
Casinos &
Gaming (10)
8
9
17.8
1.7
8.5
5
(4)
59
Department
Stores (5)
4
(10)
16.0
0.6
10.6
6
(6)
52
Divers. Commercial
Svcs. (10)
1
(26)
15.6
1.2
6.8
(20)
(10)
60
Footwear (9)
7
16
15.2
1.5
14.2
8
(7)
59
General Merch.
Stores (8)
9
24
15.9
0.7
10.6
10
1
55
Home
Furnishings (5)
15
17
22.1
1.2
13.5
36
(1)
55
Homebuilding (11)
4
71
35.2
1.5
26.3
79
1
47
Hotels &
Resorts (7)
1
29
21.3
1.5
9.5
24
(1)
60
Housewares (5)
4
5
12.0
1.0
9.8
(4)
(1)
58
Internet Retail (7)
17
22
29.5
3.2
17.4
23
(8)
50
Leisure
Products (10)
12
22
18.5
1.2
15.1
35
3
60
Movies &
Entertainment (8)
8
26
17.3
1.7
12.1
2
(13)
57
Publishing (7)
5
7
14.4
0.9
7.3
37
0
63
Restaurants (23)
5
11
20.7
1.3
10.3
6
(3)
62
Specialty
Stores (31)
6
15
18.6
0.9
12.1
13
(3)
63
S&P 1500 Cons.
Discret. Sector (249)
6
16
18.6
1.2
11.4
12
(4)
60
Notes: Averages exclude P/E ratios below zero or above 75, P/S ratios below zero or above 15, P/CFO ratios below zero or above 45, and returns or estimate changes above 200%. Quadrix scores are percentile ranks, with 100 the best.

The payroll tax could have an especially large effect on middle- and low-income consumers. Retailers might see shoppers trading down to generic products and discount stores, as they did during the recession. In addition, affluent consumers could taper spending as they deal with higher taxes on investment income.

The macroeconomic trends facing retailers apply to most industries within the consumer-discretionary sector; as the sector's name suggests, most rely on discretionary spending, the kind consumers can often delay or eliminate when times get tough. Still, analysts view the sector as a bastion of growth for the year ahead.

Because of continued weakness in government spending and caution on the part of businesses, consumers remain the power behind the economic recovery. Consumer confidence is rising and the housing market is improving. The Blue Chip Economic Indicators consensus projects consumer spending will rise 1.4% in the March quarter, accelerating to 2.6% in the December quarter.

The S&P 500 consumer-discretionary sector is expected to increase per-share earnings 13% in calendar year 2013 and 17% in 2014. The sector has reeled off 14 straight quarters of at least 8% growth in per-share profits; that includes projected 11% growth in the fourth quarter of 2012, based on a blend of actual and estimated results.

In the table below, we list our six recommended consumer-discretionary stocks. Below, we review four intriguing options.

Bed Bath & Beyond ($57; BBBY) presents a muddy picture. The retailer is benefiting from the housing recovery yet could be losing market share to online competitors. Sales rose 11% and operating cash flow 7% in the first nine months of fiscal 2013 ending February. But a pair of acquisitions contributed to that growth, and operating profit margins have slipped in two straight quarters, partly due to higher coupon redemptions.

The shares, down 25% since hitting an all-time high in June, reflect some of these concerns. At 13 times trailing earnings, the stock trades near its lowest level in four years. It also trades at a 29% discount to the median S&P 1500 specialty retailer. In Quadrix, the stock earns a Value rank of 87 and Overall score of 89.

Management plans to add 50 stores in the fiscal year ending February 2014 and ultimately envisions 1,300 locations for its namesake stores, implying a 30% bigger footprint. Bed Bath is also adding food and wine to some of its stores through Cost Plus, one of its recent acquisitions. The consensus projects 14% higher per-share profits for the February quarter, followed by 10% growth in the fiscal year ending February 2014. Bed Bath & Beyond is a Buy and a Long-Term Buy.


Comcast ($40; CMCSa) sales rose 12% last year, while cash provided by operations increased 4% to $14.85 billion. Comcast let about $10 billion in cash accumulate on its balance sheet in preparation for paying $16.7 billion for the remaining 49% interest in NBC Universal. The deal values NBC Universal at roughly $39 billion, compared to $37 billion in 2011, when Comcast bought its initial stake. The deal comes at a time when NBC network suffers from slumping ratings. But it also gives Comcast a partial hedge against escalating costs for programming, which management sees rising at a low-double-digit rate in 2013, versus 7% last year.

The stock has returned 37% in the past year, outpacing the 18% average return for S&P 1500 broadcasting and cable-TV stocks. Comcast shares now trade at 21 times trailing earnings, a 20% premium to its peer-group median. However, at 17 times estimated 2013 earnings, the stock trades roughly in line with its peer group. The consensus calls for Comcast to grow 2013 earnings per share 23% to $2.37 (with nearly half of the growth coming from the NBC Universal deal). Comcast is a Long-Term Buy.


Foot Locker ($33; FL) operates 3,335 stores in 23 countries under brands including Foot Locker, Footaction, and Champs Sports. The shares have dipped 8% since the end of November, partly on soft trends in footwear sales industrywide. This weakness was driven by cold-weather boots and running shoes, where Foot Locker has less exposure than its rivals.

Foot Locker is scheduled to report January-quarter results and disclose its year-ahead guidance March 8. The consensus anticipates 31% higher earnings per share on sales growth of 12%. Foot Locker plans to boost capital spending 35% to $220 million in the fiscal year ending January 2014 to remodel its stores, invest in the digital business, and continue expansion in Europe. In February, Foot Locker also hiked the quarterly dividend 11% to $0.20 per share. At 14 times trailing earnings, shares trade 34% below their three-year average and 8% below the median apparel retailer in the S&P 1500 Index. Foot Locker is a Focus List Buy and a Long-Term Buy.


Macy's ($40; M) earned $2.05 per share in the January quarter excluding special items, up 21% (helped by an extra week in the quarter) and $0.06 above the consensus. Total sales grew 7%, while same-store sales rose 3.9%. Online sales jumped 48%. For the fiscal year ending January 2014, management sees per-share profits of $3.90 to $3.95, versus $3.46 last year and the consensus of $3.81 at the time of the announcement. Same-store sales are projected to advance 3.5% for the year. Shares rallied on the results.

The department store's Overall rank has slipped to 78 from 90 at the end of October. But shares trade at less than 13 times trailing earnings, a 5% discount to their three-year average and 8% below their peer group. The stock trades at just 10 times projected fiscal 2014 earnings, versus the median P/E ratio of 11 for S&P 1500 department stores.

In other news, Macy's CEO Terry Lundgren testified at a trial, alleging Martha Stewart Living breached an exclusivity contract. Macy's hopes to block J.C. Penney ($21; JCP) from opening Martha Stewart shops inside the rival's stores in May. Macy's is a Buy and a Long-Term Buy.

RECOMMENDED CONSUMER-DISCRETIONARY STOCKS
--------------- Valuation ---------------
Est.
Year-
To-Year
EPS Chg.,
Next
6 Mos.
(%)
90-Day
Chg. In
EPS
Est.
For Next
6 Mos.
(%)
Performance
Price/Earnings
Price/Oper.
-- Cash Flow --
--------- Quadrix Scores ---------
Sector-Specific
------ Scores ------
Company (Price; Ticker)
YTD
Total
Return
(%)
1-Yr.
Total
Return
(%)
Trailing
Industry
Average
Trailing
Industry
Average
Momen-
tum
Value
Earns.
Ests.
Overall
12-
Factor
Sector
Reranked
Overall
Bed Bath & Bey.
($57; BBBY)
1
(6)
12.9
18.6
10.2
12.1
11
(3)
53
87
50
89
83
63
Comcast
($40; CMCSa)
5
37
20.6
17.2
7.2
8.8
19
5
78
65
93
94
96
95
DirecTV
($48; DTV)
(4)
5
10.8
17.2
5.2
8.8
16
(7)
62
95
12
88
58
59
Foot Locker
($33; FL)
3
17
13.8
18.6
10.4
12.1
18
0
86
77
70
93
78
87
Macy's ($40; M)
1
8
12.5
16.0
7.0
10.6
17
(1)
66
83
81
78
17
70
Magna Int'l
($51; MGA)
3
12
9.3
17.5
6.4
10.6
(13)
5
92
85
92
98
91
99
Notes: Quadrix and sector-specific scores are percentile ranks, with 100 the best.

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