The Zacks Retail – Discount Stores industry comprises companies that offer apparel, accessories, footwear, beauty products, personal and baby care products, cleaning products, pet supplies, and food and beverage products. The industry participants also provide home textiles, home furnishings, housewares, toys and seasonal décor products. These companies sell their products either through stores or digital channels, or both. Some of the industry players operate membership shopping warehouse clubs, offering branded and private-label products in a range of merchandise categories.

Let’s take a look at the industry’s four major themes:

• The industry’s prospects are correlated with the purchasing power of consumers. Consumer spending activity, one of the pivotal factors shaping the economy, regained momentum with Americans back on the streets following the easing of coronavirus-induced lockdown. Undoubtedly, gradual reopening of the economy and measures undertaken to support households such as stimulus checks and enhanced unemployment benefits lifted demand. As a result, U.S. retail sales rebounded sharply in May, increasing 17.7% — the highest since 1992. However, market pundits cautioned that the path to recovery looks long and bumpy, given millions of job losses since February, historically high unemployment rate of 13.3% and resurgence of coronavirus cases that may result in the rolling back of reopening plans.
   
• The strategy to sell products at discounted prices has helped industry players expand customer base, which comprises low-to-middle income groups. Under the current circumstances, people are showing a preference for discount stores for essentials or other daily purchases. Clearly, a differentiated product range resonates well with customers’ spending habits. It is true that some of the industry participants such as Burlington Stores, Inc. (BURL Quick QuoteBURL - Free Report) , Ross Stores, Inc. (ROST Quick QuoteROST - Free Report) and The TJX Companies, Inc. (TJX Quick QuoteTJX - Free Report) were hurt by the temporary closure of stores due to the pandemic that also brought a paradigm shift in consumer buying behavior. People have now started to shop more of essential items rather than discretionary purchases, benefitting players like Dollar Tree, Inc. (DLTR Quick QuoteDLTR - Free Report) . Now with the gradual reopening of stores, companies are witnessing improvement in traffic levels and sales. Matthew Shay, chief executive of the National Retail Federation, has said “The most important thing now is to keep these retail stores open for business and not penalize them by closing their doors in the event of a coronavirus surge.”
   
• With the evolving consumer shopping pattern and behavior, industry participants are playing dual in-store and online roles. In fact, the companies’ digital businesses have played a key role amid the lockdown. Certainly, companies are committed to addressing the challenges related to the pandemic. In this respect, the industry players are directing resources toward digital platforms, accelerating fleet optimization, augmenting supply chain and focusing on improving financial flexibility. The industry players are also focusing on superior product strategy and advancing omni-channel capabilities. In the current situation, the companies are even offering no-contact delivery option, low-contact pickup service and ship-to-home orders. They are also resorting to contactless payment solutions. Companies are investing in renovation, improved checkouts and mobile point-of-sale capabilities to keep stores relevant.
   
• The companies in the industry are vying for a bigger share on attributes such as price, products and speed to market. Further, the increasing dominance of Amazon (AMZN Quick QuoteAMZN - Free Report) has made the retail-discount space highly competitive. This has compelled a number of players to strengthen their digital ecosystem and boost shipping and delivery capabilities. While these endeavors drive sales, they entail high costs. Apart from these, any deleverage in SG&A rate, higher labor and occupancy costs, and increased marketing and other store-related expenses might put pressure on margins. Industry experts pointed out that the companies’ bottom line may be impacted by additional employee payments and benefits along with investments undertaken to preserve safety and health of customers and team members amid the coronavirus crisis. Again, shift in channel mix toward digital fulfillment, transition toward lower-margin categories and decline in higher-margin discretionary items’ sales are likely to hurt margins. Nonetheless, companies are containing costs, optimizing inventory and prioritizing capital expenditures.

Zacks Industry Rank Indicates Bright Prospects

The Zacks Retail – Discount Stores industry is housed within the broader Zacks Retail – Wholesale sector. The industry currently carries a Zacks Industry Rank #37, which places it in the top 15% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bright near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the top 50% of the Zacks-ranked industries is a result of positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually becoming hopeful of this group’s earnings growth. Since the beginning of June 2020, the industry’s earnings estimate for the current year has moved up approximately 1.1%.

We will present a few stocks that have the potential to outperform the market based on a strong earnings outlook. But it’s worth taking a look at the industry’s shareholder returns and current valuation first.

Industry vs. Broader Market

The Zacks Retail – Discount Stores industry has underperformed the broader Retail – Wholesale Sector but has outperformed the Zacks S&P 500 composite over the past year.

Stocks in this industry have collectively advanced 10% compared with the Zacks S&P 500 Composite’s increase of 2.1% and the Zacks Retail – Wholesale sector’s rise of 18% in the said time frame.

One-Year Price Performance



Industry’s Current Valuation

On the basis of forward 12-month price-to-earnings (P/E) ratio, which is commonly used for valuing retail stocks, the industry is currently trading at 27.54 compared with the S&P 500’s 21.53 and the sector’s 32.26.

Over the last five years, the industry has traded as high as 30.22X and as low as 17.93X, with median being at 20.07X, as the chart below shows.

Price-to-Earnings Ratio (Past 5 Years)



Bottom Line

The COVID-19 crisis is a litmus test for all consumer-driven industries. Better pricing, effective inventory management, and merchandise and operational initiatives should boost revenues of the industry constituents. However, stiff competition and costs associated with promotional activities are major deterrents. Moreover, investments in pay and benefits for frontline team members, shift in channel mix toward digital fulfillment, and transition toward lower-margin categories are likely to keep margins under pressure.

That said, we are presenting two stocks from the Retail – Discount Stores industry that are well positioned to outperform the market. Of these, the first stock sports a Zacks Rank #1 (Strong Buy) and the next carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Big Lots, Inc. (BIG Quick QuoteBIG - Free Report) : Shares of this closeout retailer have surged about 53% in a year. The Zacks Consensus Estimate for the company’s current-fiscal EPS has climbed 12.3% in the past 30 days. The company has a trailing four-quarter positive earnings surprise of 62.2%, on average, and an estimated long-term earnings growth rate of 7.1%.

Price and Consensus: BIG


 
Dollar General Corporation (DG Quick QuoteDG - Free Report) : For this discount retailer, the consensus EPS estimate for the current fiscal year has risen 2.6% over the past 30 days. Moreover, the company has a trailing four-quarter positive earnings surprise of 16.9%, on average. The stock, which has rallied roughly 39.4% in a year, has an estimated long-term earnings growth rate of 12.4%.

Price and Consensus: DG



We are also presenting two stocks with a Zacks Rank #3 (Hold) that investors may currently retain in their portfolio.

Costco Wholesale Corporation (COST Quick QuoteCOST - Free Report) : This operator of membership warehouses has a trailing four-quarter positive earnings surprise of 1.9%, on average. The stock, which has gained roughly 12.5% in the year, has an estimated long-term earnings growth rate of 8.4%.

Price and Consensus: COST



Target Corporation (TGT Quick QuoteTGT - Free Report) : Shares of this general merchandise retailer have gained approximately 34.6% in a year. The Zacks Consensus Estimate for the company’s current-fiscal EPS has been stable in the past 30 days. The company has an estimated long-term earnings growth rate of 6.1%. It has a trailing four-quarter positive earnings surprise of 14.4%, on average.

Price and Consensus: TGT

 

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