Don't Shrink From Consumer Stocks

11/7/2016


Anyone who has worked in retail likely recalls the concept of shrink, or unaccounted merchandise. Inevitably, the inventory claimed by a retailer's computer system will exceed what's physically counted in stores and warehouses. There are no shortage of reasons for shrink: theft, negligence, or the rare instance of shipments getting tossed off the side of freighters during violent storms. But shrink always causes the same problem: the missed opportunity to make a sale.

In the stock market, missed opportunities take many forms, but usually leave investors with the same stomach-churning feeling of wanting to lose their lunch over the side of a boat. Right now, investors should not shrink from the consumer-discretionary sector, an area with attractive operating momentum and growth prospects that has suddenly fallen out of favor.

Entering 2016, S&P 1500 consumer-discretionary stocks had delivered an average annualized return of 19% over the past six years, higher than any other sector and well above the index's 13% return. However, consumer-discretionary stocks have averaged flat returns including dividends this year, ranking 10th out of the index's 11 sectors, as shown below.

Recent weakness has dragged the sector's average trailing P/E ratio down to 19 — only financial stocks look cheaper relative to trailing earnings. The sector offers a 15% discount to the broad index, as shown below, more than twice the discount it has averaged over the past decade. Additionally, 48% of consumer-discretionary stocks have trailing P/E ratios more than 10% below their own five-year averages, versus 25% of the broad index. In Quadrix, consumer-discretionary stocks average Value scores of 69, tops among the 11 sectors, and rank second for Overall.

DISCRETIONARY STOCKS A RELATIVE VALUE
S&P 1500 consumer-discretionary stocks look unusually cheap relative to the broad index. The average stock in the sector trades at 19 times trailing earnings, versus the index's average trailing P/E ratio of 22, for a 15% discount. Over the past decade, consumer-discretionary stocks averaged a 6% discount to the index. Of the sector's five groups, only consumer services has typically traded at a premium (5%) to the S&P 1500 Index for the past decade; it currently trades at a 4% discount. The other four groups also look cheaper than normal relative to the index.
------------- Consumer-Discretionary Groups -------------
Trailing P/E Ratio
S&P
1500
Index
Consumer-
Discretionary
Sector
Autos &
Component
Consumer
Durables
& Apparel
Consumer
Services
Media
Retailing
Current
22.0
18.7
13.6
16.9
21.1
17.9
20.0
10-year average
20.8
19.6
17.8
18.7
21.8
18.1
19.6
Curr. discount to index (prem.) (%)
15
23
23
4
19
9
10-yr. avg. discount
to index (prem.) (%)
6
10
10
(5)
13
5

Structural changes add some risk to pockets of the consumer-discretionary space. First, a greater share of U.S. consumers' wallets is going toward services, such as travel, entertainment, and health care. That hurts demand for electronics, apparel, and other products. Second, many retailers still struggle with recasting their business models to integrate the internet with their physical stores.

These trends were apparent in the first nine months of 2016, based on sales data compiled by the U.S. Census Bureau. U.S. retail and food services sales have risen 3% this year, driven by 11% growth for web-based retailers and 6% for restaurants. Year-to-date sales are down 5% at department stores and 3% at electronics shops.

Yet U.S. consumer confidence remains upbeat, buoyed by higher wages and job growth. The Conference Board's consumer-confidence index slipped in October after hitting a nine-year high in September but lingers at historically high levels.

The table below lists our recommended consumer-discretionary stocks, and below we review four that look especially attractive right now.

Comcast ($61; CMCSa) grew September-quarter earnings per share 15% on 14% higher sales, topping consensus estimates for both metrics for the third consecutive quarter. The Summer Olympics stoked growth for the NBCUniversal unit, while the cable business benefited from an expanding subscriber base. Comcast's net subscriber additions were 32,000 for video and 330,000 for high-speed internet, both up from the year-ago quarter. Average revenue per subscriber increased 4%.

Amid all the handwringing over cord-cutting, Comcast has added a net 170,000 video subscribers and 1.4 million internet subscribers over the last year. Comcast's comeback in video could get undercut if AT&T gains traction with its recently announced streaming service, priced at $35 a month and carrying more than 100 channels. Comcast executives say the potential market is big enough to accommodate new entrants, noting that about 20 million U.S. homes don't currently subscribe to pay-TV.

At 18 times trailing earnings, Comcast shares do not look especially cheap relative to their historical or industry norms. But the stock trades at just 16 times estimated 2017 earnings, a 26% discount to the median for S&P 1500 cable stocks. Comcast's profits are projected to rise 11% in the December quarter and 8% in 2017. Comcast is a Focus List Buy and a Long-Term Buy.


Disney ($92; DIS) will post results after the market closes on Nov. 10. The consensus anticipates per-share profits of $1.16, down 3% on roughly flat sales of $13.56 billion. Analyst estimates have steadily contracted over the past 90 days, typically a troubling sign. But Disney has proven itself capable of managing expectations, topping the consensus profit estimate in 11 of the past 12 quarters, and the sales target in nine of the past 12 quarters.

Disney's stock, down 13% in 2016, already reflects a hefty dose of pessimism. Shares trade near their lowest level in three years relative to trailing earnings and cash flow. The P/E ratio of 16 lingers 16% below its five-year average of 19 and 13% below the average for S&P 1500 consumer-discretionary stocks. If Disney were to merely meet the lowest analyst profit estimate of $5.64 per share for fiscal 2017 ending September, and its P/E ratio climbs to 18, the shares would rally 10% over the next 12 months. Disney is a Long-Term Buy.


Two key suppliers for Foot Locker ($67; FL), Under Armour ($31; UA) and Nike ($50; NKE), posted disappointing results in the past month. Despite the headline numbers, the reports did little to dim our bullish stance on Foot Locker. The market for athletic apparel and footwear keeps expanding, though its composition appears to be shifting, with Adidas gaining ground. Foot Locker is seeing broad growth across product lines and geographic markets, limiting exposure to a single brand or region. Finally, foot traffic is rising at Foot Locker stores as shoppers flock to exclusive merchandise unavailable on Amazon.com ($766; AMZN). Foot Locker's shares remain up 8% since the retailer posted impressive July-quarter results in August.

Foot Locker's same-store sales have risen in 26 straight quarters; growth has surpassed 5% in 20 of those quarters — more than any other S&P 1500 apparel retailer. In August, management reaffirmed that same-store sales should climb by mid-single-digits in fiscal 2017 ending January. Year-over-year comparisons for the first half of fiscal 2018 appear modest, setting up Foot Locker to continue its growth trajectory. Foot Locker is a Buy and a Long-Term Buy.


Lear ($121; LEA) shares have returned 9% including dividends over the past three months, most recently rallying on a strong September-quarter report. Operating profit margin rose for the 11th straight quarter. Sales rose 5%, marking the 17th consecutive quarter of growth and its strongest quarterly gain since the three months ended December 2014.

Slowing U.S. auto sales and Ford Motor's ($11; F) production shutdowns could hinder Lear's near-term results. But the company continues to win new contracts with other carmakers, boosting its backlog. Moreover, Lear's electrical and seating units are both gaining market share, particularly in Europe and Asia. Finally, global demand is rising for sport-utility vehicles, which tend to require a greater amount of Lear's components.

Analyst estimates have risen since Lear's quarterly report, with the consensus projecting December-quarter earnings per share of $3.40, implying 6% growth on 1% higher revenue. Looking further out, management said it expects sales to advance well above the industry growth rate over the next five to seven years. Lear is a Focus List Buy and a Long-Term Buy.

RECOMMENDED CONSUMER-DISCRETIONARY STOCKS
12-Month
--- Change ---
Est. EPS
Growth,
Current
Year
(%)

Trailing
--- P/E Ratio ---

P/E
Based On
Curr.-Yr.
EPS Est.
YTD
Total
Return
(%)
----------------- Quadrix Scores -----------------
Company (Price; Ticker)
EPS
(%)
Sales
(%)
Recent
5-Year
Median
Momen-
tum
Value
12-
Factor
Reranked
Overall
Overall
S&P 1500
Group
Comcast ($61; CMCSa)
4
8
7
18
18
18
11
44
72
56
32
64
Media
D.R. Horton ($29; DHI)
23
14
17
13
16
12
(10)
76
85
84
84
95
Durables
Disney ($92; DIS)
23
9
12
16
19
16
(12)
62
72
40
47
78
Media
Foot Locker ($67; FL)
13
4
11
15
15
14
5
70
75
86
87
94
Retailing
Lear ($121; LEA)
23
3
26
9
10
9
(1)
84
98
99
100
99
Auto
LKQ ($32; LKQ)
22
19
26
19
22
18
7
79
65
75
58
78
Retailing
Mohawk Industries ($179; MHK)
30
10
22
15
22
14
(6)
94
76
47
84
95
Durables
S&P 1500 cons.
discretionary avg.
8
5
7
19
20
18
2
56
69
50
49
69
S&P 1500 Index
average
3
3
4
22
21
21
11
52
56
50
49
59
Note: Quadrix scores are percentile ranks, with 100 the best.

 


Current Hotline

Stock Spotlight

Individual Stock Reports

ISRs make stock research easy!

Perhaps the most valuable two page reports available anywhere.

All the data you would normally have to plow through years of 10-K filings, earnings reports, and reams of market data to assemble — yours all in one concise report.

ISRs contain our proprietary Quadrix scores — find out how we rate all the stocks in the S&P 500.

Visit us at individualstockreports.com