Retailers Snared In Online Web

8/7/2017


Consumer sentiment is bullish and wages are rising, typically the recipe for a strong retail enviornment. Yet the average retail stock in the S&P 1500 Index has fallen 5% this year. The recent slump makes stocks in key retail industries look unusually cheap. But their operating momentum also appears sluggish, compared to both historical norms and other industries.

Structural changes add additional risk to the retail space. First, a greater share of U.S. consumers’ wallets is going toward services, such as travel, entertainment, and health care, hurting demand for electronics, apparel, and other products. More problematic, traditional retailers have yet to devise a business model that shields them from Amazon.com ($996; AMZN), which seems determined to engulf the entire industry.

Up to this point, internet retailers’ effect on the revenue of traditional retail industries is far smaller than their stock-market value might suggest. We draw that conclusion after reviewing more than 80 retailers currently in the S&P 1500 Index with 10 years of history. Internet retailers currently generate 9% of the group’s sales, versus 1% a decade ago; the impact is broad, with no retail industry seeing its share of revenue fall more than 2%. But the total stock-market value of internet retailers has soared to 37% of the S&P 1500 retail industry, up from 6%. See the table below for more details.

INTERNET DRINKS UP TRADITIONAL RETAIL'S MILKSHAKE
Internet companies including Amazon.com ($996; AMZN), Priceline ($2,021; PCLN), and Netflix ($181; NFLX) account for 9% of retailer sales, up from 1% a decade ago, based on more than 80 retailers currently in the S&P 1500 Index with 10 years of history. Their market value has jumped to 37% of the retail industry.
Share Of
----- Retail Revenue -----
Share Of Retailer
----- Market Value -----
S&P 1500 Retail Industry
Current
(%)
10 Years
Ago
(%)
Current
(%)
10 Years
Ago
(%)
Internet & direct marketing retail
9
1
37
6
Apparel retail
6
7
7
9
Department stores
4
6
1
8
General merchandise stores
6
7
3
7
Specialty stores
4
5
3
5
Food & staples retailing
52
53
29
41
Other retail
19
21
22
24
Company (Price; Ticker)
Amazon.com ($996; AMZN)
7
1
26
4
Wal-Mart Stores ($81; WMT)
24
29
13
23

Even retailers long viewed as safe from online competition are suddenly facing new threats. Three recent examples come to mind:

• Kroger ($25; KR) and other grocers will likely face new competition from Amazon following its $13.7 billion acquisition of Whole Foods Market ($42; WFM). Amazon announced the pending deal in June.

• Foot Locker’s ($48; FL) largest supplier, Nike ($60; NKE), announced in June plans to begin selling some products through Amazon and Facebook’s ($169; FB) Instagram.

• Sears ($8; SHLD) agreed in July to sell its Kenmore appliances on Amazon’s website. The pact represents Amazon’s latest push into appliances and possibly furniture, bulky products that are expensive to ship

Most consumers favor checking out shoes, big-ticket purchases, and home-improvement products in person. But everyone loves a bargain, whether shopping online or scooping up value stocks. For that reason, it’s inevitable that preferences change. Of course, the speed of that change is difficult to assess, as is whether retail stocks’ current valuations represent a buying opportunity or value trap.

S&P 1500 RETAIL INDUSTRIES
Most retail industries look cheap relative to the broad S&P 1500 Index. But many of these same industries suffer from weak operating momentum and slumping share prices. We ranked each retail industry’s average returns, growth, valuation, and Quadrix scores versus the index’s 121 industries with at least three stocks.
12-Month
Total Return
Est. EPS, Curr.
Fiscal Year
--------- P/E Ratio ---------
---------------- Quadrix Scores ----------------
12-Month
EPS Change
Trailing
Current Year
Momentum
--- Value ---
-- Overall --
S&P 1500 Retail Industry (Number Of Stocks)
Avg.
(%)
Rank
Avg.
(%)
Rank
Avg.
(%)
Rank
Avg.
Rank
Avg.
Rank
Avg.
Rank
Avg.
Rank
Avg.
Rank
Apparel (24)
(27)
119
(6)
96
(3)
106
13
6
14
6
26
118
92
2
63
43
Automotive (11)
(13)
115
(1)
82
2
81
15
12
14
12
35
108
84
8
65
37
Computer &
electronics (3)
17
29
9
45
(1)
99
11
1
31
110
35
107
89
4
68
31
Department stores (5)
(10)
111
(10)
105
(1)
97
12
4
12
4
37
104
93
1
69
28
Distributors (4)
(2)
95
5
66
12
33
24
73
22
62
39
101
57
68
58
66
Food & staples (9)
3
83
(5)
94
2
84
20
81
20
77
35
105
71
27
64
38
General merchandise (6)
(5)
102
21
8
9
53
21
46
19
37
56
36
69
30
73
19
Home improvement (4)
29
8
15
18
15
17
24
77
22
65
51
60
54
76
60
57
Homefurnishing
retail (7)
20
23
(13)
111
10
46
21
48
19
34
44
86
83
9
78
9
Internet & direct
marketing (10)
31
6
11
34
14
21
30
98
29
103
57
32
40
104
59
59
Specialty stores (17)
(15)
116
2
76
8
56
17
18
15
15
49
63
84
7
72
23
S&P 1500 retailer
average
(5)
0
5
18
18
40
77
66
S&P 1500 Index
average
7
4
6
23
22
51
57
59
Note: Quadrix scores are percentile ranks, with 100 the best. Averages exclude P/E ratios above 75 and below 0, as well as growth above 75% and below -75%.

 

For our money, we only recommend one retail stock, Lowe’s ($78; LOW), for purchase. Lowe’s and two other stocks are reviewed below.

Lowe’s ($78; LOW) has tested investors’ patience in the past couple months. The shares fell on a messy April-quarter report and sold off again when Amazon.com ($996; AMZN) secured a deal with Sears ($8; SHLD) to sell Kenmore appliances online. Appliances are Lowe’s third-biggest product category, representing 11% of annual sales. Its rivals have similar exposure, with Home Depot ($151; HD) relying on appliances for 8% of sales and Best Buy ($59; BBY) 9%. But appliances have been a less-important growth driver for Lowe’s than its rivals in the past year.

It’s easy to see Amazon’s interest in pushing into the home-improvement market. Today’s low housing inventory has encouraged more Americans to renovate their existing homes rather than buy new ones. U.S. spending on home remodeling is projected to rise 7% to $316 billion this year, says Harvard University’s Joint Center for Housing Studies. So far, the products sold by Lowe’s have withstood threats from online competition. Bulky appliances and building materials can be difficult to ship, while shoppers prefer to view paint samples and home fixtures in person.

Even with Amazon looming in the background, Lowe’s still looks like a good play for investors seeking exposure to the retail industry, a space with few appealing options right now. The stock offers solid near-term growth prospects and a decent valuation. The consensus targets 18% higher per-share profits for the July quarter and 16% for fiscal 2018 ending January. At 17 times estimated 2018 earnings, the stock trades below its four-stock industry median of 24. Additionally, we’re encouraged that Lowe’s acquired Maintenance Supply Headquarters, a $512 million deal completed in June. The takeover boosts Lowe’s presence with professional contractors, an end market fueling Home Depot’s recent growth. Lowe’s is a Buy and a Long-Term Buy.


Priceline Group ($2,021; PCLN), an online travel agency, is one of 10 S&P 1500 stocks in the internet and direct-marketing retail category. The company markets a network of 584,000 traditional hotel properties, stretching across about 70 countries. Over the past 12 months, Priceline grew per-share profits 12%, revenue 16%, and operating cash flow 22%.

Its Quadrix Overall score of 74 is supported by above-average ranks for five of six category scores. Priceline has a Value score of just 28, though its trailing P/E ratio is 29 and forward P/E is 28 — lower than all but one stock in its industry. Scheduled to post June-quarter results on Aug. 8, Priceline is expected to report earnings per share of $14.18, up 13%, on revenue growth of 17%. Priceline is rated A (above average).


Wal-Mart Stores’ ($81; WMT) operating momentum has failed to keep pace with that of smaller and more nimble retailers over the past decade. Its 12-month revenue is up 34% from 10 years ago, while the broad retail group’s combined sales grew 60%, based on the 87 retailers currently in the S&P 1500 Index that have 10 years of sales data.

That sluggish growth is largely due to the emergence of Amazon.com ($996; AMZN) and the difficultly in moving the needle for a company of Wal-Mart’s size. But efforts to build its internet business have begun to pay off. Online sales surged 63% in the April quarter, helped by Wal-Mart’s strategy of providing discounts to online shoppers who pick up their purchases at stores.

Although Wal-Mart’s sales and profit growth remain meager, free cash flow surged 24% to $14.13 billion for the 12 months ended April. The stock trades in line with industry peers based on trailing earnings and sales, but looks cheap relative to operating cash flow and free cash flow. Wal-Mart Stores is rated A (above average).

MONITORED RETAIL STOCKS
The retail group offers slim pickings for investors. We only recommend Lowe’s ($78; LOW), in bold, for purchase.
Total Return
12-Month
--- Change ---
Est. EPS,
Current
Fiscal
Year
-- P/E Ratio --
----- Quadrix Scores -----
Company (Price; Ticker)
Past 3
Months
($)
YTD
(%)
EPS
(%)
Sales
(%)
Trailing
Curr.
Year
Momen-
tum
Value
Overall
Industry
Rating
Amazon.com
($996; AMZN)
5
33
(24)
24
24
253
266
39
13
35
Internet &
direct mktg.
B
AutoZone ($543; AZO)
(21)
(31)
7
2
7
13
12
24
94
69
Automotive
B
Costco ($161; COST)
(6)
5
8
5
8
29
28
53
47
60
Food & staples
B
CVS Health
($80; CVS)
2
3
1
12
1
14
14
40
96
82
Food & staples
B
Home Depot
($151; HD)
(2)
14
12
6
12
23
21
54
53
74
Home
improvement
A
Kroger ($25; KR)
(14)
(28)
(6)
5
(6)
12
12
15
96
67
Food & staples
B
Lowe’s ($78; LOW)
(8)
11
16
11
16
19
17
60
79
89
Home
improvement
Buy *
Netflix ($181; NFLX)
16
46
170
34
173
220
156
92
14
77
Internet &
direct mktg.
B
Priceline
($2,021; PCLN)
7
38
12
16
12
29
27
59
27
72
Internet &
direct mktg.
A
Target ($57; TGT)
2

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