Wednesday - March 29, 2006

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Concerns on the macroeconomic level have led directly to concerns about the retail industry lately. We spoke with senior retail analyst Rob Plaza, CFA for his views on this topic, both from an overview perspective and by way of discussing a few specific retail companies.

How are current concerns about consumer spending starting to affect the retail industry?

Well, the biggest concerns are those that have been with us awhile now: higher oil prices leading to higher gas prices at the pump, rising interest rates, and so forth. But until the last few months, rising interest rates haven’t really hurt real estate prices. Just last week, there was a report out about prices of new homes coming down, the first time in awhile there’s been a decline in the average spending price in many years.

So finally the interest rate cycle has caused real estate to cool off, and that’s where a lot of growth has come from in the economy. Not coincidentally, this is also where a lot of money has been pulled out by consumers and spent on retail products. The biggest concern now is that potential customers can no longer tap their house, can’t refinance their mortgage, and can’t take out a home equity loan and have what many people had been looking at as essentially free money.

With higher gas prices, that’s just something you learn to live with, so you get used to paying more. But that also means people have less money to spend. They don’t go shopping at their favorite retailer and instead go to discount stores or wait for special events like 24-hour sales.

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Zacks Equity Research continued...

Are you seeing this happening now, or is it more something you’re expecting to see in the future?

Both, really. It depends on the retailer. Things like this tend to come out pretty spotty. I’ll get e-mails from companies I follow or used to follow, like Circuit City (CC), who just sent me an e-mail ahead of the flyer in the Sunday paper about a big two-day sale. This kind of thing is becoming a lot more frequent for a lot of retailers.

Are stores targeting middle-income and lower-income customers expected to feel the hurt more than high-end boutiques?

The farther down the food chain you go, the less income is coming in. If you’re a low-paid worker, you likely still have to drive your car to work, so gas prices are obviously going to hit you harder than if you’re middle-class. Higher gas prices might not even affect upper-income households’ lifestyles at all.

Now, I don’t follow Wal-Mart (WMT), but that company’s numbers have continued to be outstanding. This is a company that has been performing exceptionally well. For some of the companies I do cover in that general space, such as < Wholesale>and Fred’s, Inc. (FRED), we are seeing that stores like that are having some problems.

You’re going to be seeing – not so much on the luxury super high-end but in the sweet middle area that’s done so well over the past few years – people scaling back, and this is expected to hurt retail. These consumers won’t be buying the $1000 suit or the $150 outfit; they’ll instead maybe go off-brand to save some money, and this will cause pricing pressures across the board. One thing retailers have had going for them is that job growth and wage growth have continued to overcome problems with higher gas prices and rising inflation. For whatever reason – pay raises, working longer hours, not paying as much toward health benefits – overall wage growth has continued to outpace inflation. No one’s sure how long this can be expected to continue, but one thing’s for certain: we’re still spending gobs of money on retail at this point.

So would you be considering market-weighting or underweighting retail stocks right now?

Well, my basic answer is this: in almost any scenario, good retailers are good retailers, and that’s where you want to play. Common knowledge is to buy retailers at the end of an interest rate upcycle – and it seems as if we’re getting pretty close to that now – which tend to lift all boats. That’s when retailers’ trust goes up. When things aren’t quite so easy, companies that manage their inventories are generally best, as they are the ones making the most amount of profits per square foot. Also, companies that don’t have to resort to markdowns to sell merchandise also tend to do well.

Things are a little different for companies that are hot. Take Zumiez (ZUMZ), which is really smoking right now, as kids still love that whole skateboarder look. Zumiez is transforming from a small regional base to expanding nationally. They continue to open new stores that are very popular, which is really juicing sales right now.

Don’t high-growth companies like Zumiez tend to have staggering P/Es? What’s your take on this?

Yes, that’s definitely true of a company like Zumiez. I did manage to upgrade to a Buy a similar company called Citi Trends (CTRN) – it’s also making the move from a regional company to a national brand – when it dipped a little recently, but ZUMZ is not letting me in. I will likely make this company a Buy at some point, but I’m still looking for a reasonably good price to do that. What are some of the other Buy recommendations you have right now?

I was just going over my list today, in fact. I still like Cache (CACH) and Deckers (DECK), and I believe I will need to jack up my target on Select Comfort (SCSS) soon. And then Kirkland’s (KIRK) got so cheap that I had to make it a Buy. A kind of strange thing happened earlier this month when a press release from Kirkland’s came out saying only that the CEO had left the company. Period. No softsoaping the issue, no “going home to spend more time with the kids.” Right around that point, the stock fell to under five bucks per share.

But there’s a good story with Kirkland’s, as it is starting to move out of the big shopping malls to smaller strip malls, which is a better fit for them. The thing that’s hurting its rival companies like Pier One (PIR) is that their stores are just too big, and take up a lot of square footage. That makes a company like Pier One have to do great business all the time, and if it brings in a product people don’t want, it just kills them. So Kirkland’s – which is not as big or diverse, product-wise, as Pier One – has done a good job scaling back, I think, and this should help them going forward. Any Sells you’d care to mention?

I’ve had a few for quite awhile that might finally be upgraded soon, not necessarily because their story has gotten so much better but because earnings have finally started catching up with the share price. I’m thinking of both Dillard’s (DDS) and Saks (SKS).

I’m still most negative on Overstock.com (OSTK) – and they even had a jump recently. My negativity doesn’t even have as much to do with the company’s fundamentals as it does with the controversy over how many shares have been shorted. In a nutshell, it’s a lot; there are basically no shares left to borrow. What this does is act as rocket fuel every time a piece of good news comes out, as short-sellers rush to cover their positions. But basically, the company has a losing business model, which is the reason so many people are shorting the stock in the first place. I’m still most negative on Overstock than any other company in this space.

Rob Plaza, CFA is a senior analyst covering the retail industry for Zacks Equity Research

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MORE FROM ZACKS EQUITY RESEARCH...
 

Analyst Blog - NEW!

Get real-time market insights from Zacks Equity Research Analysts. To see their latest posts, click here.

 
BULL OF THE DAY

SABESP, ADR (SBS) - Attractive Valuation. For full Zacks research report, click here.

 
BEAR OF THE DAY

Solectron Corp. (SLR) - Low Revenue Growth. For full Zacks research report, click here.

 
ZACKS INDUSTRY OUTLOOK

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After 15 straight quarters of double digit growth, earnings are expected to slow to a still healthy 9.1% rate in the first quarter. More...

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Zacks.com offers three unique weekly commentaries that all further our mission to help you Profit from the Pros. Today is the latest installment of Screen of the Week from Kevin Matras. Each week, Kevin shares with you another winning screen he has discovered using the Research Wizard software from Zacks Investment Research. Learn more about the Research Wizard at: http://at.zacks.com/?id=2335.
 

“Winning Ways”

This week, I’m writing about a screen that uses a lot of ideas from past articles, combined together into a powerful and consistently profitable stock picking strategy.

In fact, in 2005 the average annualized gross return was up 64.5%!

I’ll go over the rest of the statistics at the end of this article. But first, the parameters;

Parameters:

• P/E using 12 month EPS Actuals <= 40
  (I’ve previously written on how focusing only on stocks with P/E’s of 20 or less would’ve kept you out of some of the best stocks over the years. And that a P/E of 20 or less isn’t a ‘magic number’. In fact, I’ve often found that some of the best stocks started with P/E’s of twice that. So in this screen, I allowed stocks to have a P/E ratio as high as 40.)
   
• Price to Book <= 2
  (In that same article, I showed that a Price/Book value of 1 or less was not a ‘magic number’ either. In fact, many of the best stocks started with P/B’s of 2 and 3 and 4. For this screen, we limited it to 2. But that’s still twice as big as the ‘magic number’ of 1.)
   
• Price >= 5
  (Most money managers won’t even look at a stock under $5, so we used this as a minimum price point.)
   
• Volume (20 day average) >= 50,000
  (Anything under 50,000 shares traded daily is excluded -- it has to be tradable. The typical stocks that make it through usually trade several hundred thousand shares daily. In fact, the average daily volume for the stocks qualifying this week is over 312,500 shares.)
   
• Zacks Rank <= 2
  (The Zacks Rank is one of the best, if not the best, rating system out there. So only stocks with a Zacks Rank #1 or #2(Strong Buy or Buy) are allowed.)
   
• % Change Actual EPS Growth Q(0)/Q(-1) >= 0
  (And I want the Earnings Estimates for the Current Quarter to be increasing. (Q(1) being the Current Quarter.) Companies that receive upward Earnings Estimate Revisions have a tendency of receiving even more upward Estimate Revisions. And this paints a solid picture moving forward.)
   
• % Change in Price over 4 weeks >= 0
  (The stocks should have either increased in price over the last four weeks or, at the very least, stayed steady. Any stock with a net breakdown in price over the last month is ignored.)
   
• Return on Equity -- Top # 5
  (I’m narrowing down all of the stocks that qualified for the above parameters to only the five with the best (highest) Return on Equity (ROE). ROE is one of the quickest ways to see whether a company is creating assets with Investors’ Cash or gobbling it up.)
   

Results:

I ran a series of tests over the last five-year time span (2001 through 2005), as well as a series of tests for each of the last five years individually. I rebalanced the portfolio every four weeks and started each run on different start dates so each test would be rebalanced over a different set of four-week periods. (This exercise was done to eliminate coincidence and verify robustness.)

In 2001, the average annualized gross returns were 48.1%.

In 2002, the average annualized gross returns were 34.2%.

In 2003, the average annualized gross returns came in at 101.7%!

In 2004, the average annualized gross returns were up 55.5%.

And in 2005, the average annualized gross returns were up 64.5%.

(I’d also like to note that I successfully tested this strategy with as few as three stocks per period and as many as 10, and they came out with very impressive returns as well.)

Of the five stocks that made it through this screen this week (3/27/06), here are three of them;

Give this winning strategy a try in your own portfolio and see how you too can start confidently beating the market. You can do it. Sign up now for your free trial to the Research Wizard stock picking and backtesting program and start making better decisions today! http://at.zacks.com/?id=2335

Discover all the Free Screening Tools on Zacks.com at: http://at.zacks.com/?id=2336.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

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Every day on Zacks.com we highlight four Zacks Rank Buy stocks. Each individual stock is chosen based on how well they match the criteria for the four main schools of investing: Aggressive Growth, Momentum, Growth & Income and Value.
 

Aggressive Growth – NutriSystem, Inc. (NTRI)

NutriSystem, Inc. (NTRI) has exceeded analysts’ earnings expectations for four straight quarters by an average margin of 31%. Two analysts raised their estimates for 2006. Estimates for 2006 increased 23% over the past 60 days. Despite the strong run in the stock, it is attractively valued. NTRI is trading at 23.4x next year's earnings estimates of $1.85 per share, well below the long-term growth rate of 37%, giving the stock a PEG ratio of 0.63. Read the full analysis on NTRI at: http://at.zacks.com/?id=2498.
 

Growth & Income – Telekom Austria AG (TKA)

Telekom Austria AG (TKA), a Zacks #1 Rank stock, recently reported a significant increase in profits. Earnings per share are forecasted to grow 12.5% over the next 3-5 years. The management board will recommend a 129% increase in its dividend, leading to a dividend of EUR 0.55 per share. The company has a return on equity of 15%, compared to 11% for the industry average. Read the full analysis on TKA at: http://at.zacks.com/?id=2499.

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Zacks Rank continued...

Momentum – United Industrial Corporation (UIC)

Just like its products, United Industrial Corporation (UIC) is headed for the sky. Thinking about it logically, one might expect defense stocks to be doing well, especially those stocks in high demand areas such as Unmanned Air Vehicles (UAVs). At least in the case of UIC, you’d be right. UIC released results for its December 2005 quarter on Mar 10, reporting earnings of 76 cents per share. That number was 68.9% above last year’s 45 cents and 28.8% above the consensus estimate. Sales were up 51.9% from the same quarter the previous year. Read the full analysis on UIC at: http://at.zacks.com/?id=2500.
 

Value – Skechers U.S.A., Inc. (SKX)

Skechers U.S.A., Inc. (SKX), a Zacks #1 Rank stock, recently reported the highest annual revenues in its history. Earnings per share are projected to grow 15.0% over the next 3-5 years. The company remains very optimistic heading into 2006. Analysts’ earnings estimates for fiscal 2006 and fiscal 2007 have been on the rise. SKX has a price-to-book (P/B) multiple of 2.6. Read the full analysis on SKX at: http://at.zacks.com/?id=2501.

 
Zacks Rank Resources

• View All Zacks #1 Rank stocks: Go to: http://at.zacks.com/?id=2383.
   
• Free Zacks Rank Guide: Learn how to use the Zacks Rank to pick more profitable stocks. Get the guide: http://at.zacks.com/?id=2545.
   
• Zacks Advisor: Discover Ben Zacks' hand picked #1 Rank stocks on his Timely Buys list at: http://at.zacks.com/?id=2546.
   
• Zacks Wealth Management: Own all the Zacks #1 Ranked stocks in a portfolio managed by Zacks. Learn more at: http://at.zacks.com/?id=2547.

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Here we cast the spotlight on a timely Featured Expert commentary that recently appeared on Zacks.com. Following the article you will find previews of other profitable commentaries with insights and recommendations from leading investment experts.

 
a) Jim Collins, Editor of OTC Insight
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There were only a few economic reports last week, and they gave investors little insight into what the Federal Reserve will do in the near future with interest rates. While new home sales plummeted in February, durable goods orders rose a higher-than-expected 2.6% during the same time. Likewise, inflation at the producer level declined sharply in February, but was up moderately when excluding food and energy prices. Insight believes these and other indicators point to a moderately expanding economy with contained inflation. This type of scenario would augur for a stable interest rate environment.

The Fed is almost certain to raise rates today. However, the next meeting is not until May 10. This may give the Fed enough time to determine no further increases are needed. Should the Fed raise rates during its May meeting, it would likely be the last hike until economic or inflation data warrant otherwise.

Next week will kick off the start of what is expected to be a positive earnings season. As long as the Fed does not say anything to spook investors, stocks will be largely free to trade in accordance with their results and outlook. This week could be the last chance for investors to establish positions before the next potential move upward in the stock market. Valuations remain reasonable, and with the exception of the last half of 2005, are at their lowest levels in 10 years when measured by the S&P 500. A sound economy, coupled with solid earnings growth, makes it prudent to add to positions under general market declines.

 
Stock Picks:

Illumina (ILMN) is a leading developer of next-generation tools for the large-scale analysis of genetic variation and function. The company's tools will provide information that could be used to improve drugs and therapies, customize diagnoses and treatment, and cure disease. The company is developing a comprehensive line of products that can address the scale of experimentation and the breadth of functional analysis required to achieve the goals of molecular medicine.

Time Warner Telecom (TWTC) is a leading fiber facilities-based integrated communications provider offering local business last mile broadband connections for data, high-speed Internet access, local voice and long distance services. The company customers are principally telecommunications-intensive business end- users, long distance carriers, Internet service providers wireless communications companies and governmental entities.

Schick Technologies (SCHK) designs, develops and manufactures innovative digital radiographic imaging systems and devices for the dental and medical markets. The company's products, which are based on proprietary digital imaging technologies, create instant high resolution radiographs with reduced levels of radiation. The company's CDR system uses an intra-oral sensor to produce instant, full size, high resolution dental x-ray images on a color computer monitor without film or the need for chemical development.

 
Company News

Powerwave Technologies (PWAV) has deployed a multi-technology, multi-carrier wireless coverage system designed to enhance the Chicago Transit Authority's (CTA) existing two-way radio system and improve redundant subway communication options for CTA, Chicago Police Department and Chicago Fire Department/EMS personnel. In addition, the system will be able to accommodate commercial services, which will allow customers to use their wireless devices throughout CTA's subway system and provide an additional revenue stream for the agency.

 
About Jim Collins’ OTC Insight newsletter

OTC Insight® specializes in growth stocks, particularly in the small to mid-cap range. This monthly publication, which focuses on Nasdaq listed stocks, is a by-product of the research we use to select stocks for our managed client portfolios through Insight Capital Research and Management, Inc.® http://at.zacks.com/?id=2399
 

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MORE FEATURED EXPERTS...

b) Refining Looks Good

Jack Adamo likes domestic refiners. Learn why and check out the other commodities he highlights: More...
 

c) A Play for the Bulls

Dr. Edward Olmstead outlines a bullish trade on a company in the insurance arena. More...
 

OTHER TOOLS FROM ZACKS

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At the heart of Zacks Investment Research is the Zacks Rank investment philosophy that continues to vastly outperform the market. Our Zacks #1 Ranked (Strong Buys) have produced the following results for investors:

• +32.5% average annual return since 1988 versus +11.8% for S&P 500
• Outperformed S&P 500 in 17 of the last 18 years
• +43.8% total return from 2000 to 2002, which was the worst bear market in over 60 years.
• +18% in 2005

And just as importantly, the Zacks #5 Rank (Strong Sell) List has alerted investors as to which stocks to dump from their portfolios to avoid unnecessary losses.

To truly take advantage of the Zacks Rank, you need to first understand how it works. That's why we created the free special report: "Zacks Rank Guide: Harnessing the Power of Earnings Estimate Revisions". Download a free copy now to prosper in the years to come, by visiting: http://at.zacks.com/?id=2332.

Or view the full list of Zacks #1 Ranked stocks at: http://at.zacks.com/?id=2279.

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The Zacks Performance Rank performance is the total return of equal weighted simulated portfolios consisting of those stocks with the indicated Zacks Rank net of fees. Results reflect the reinvestment of dividends and other earnings. Simulated results do not represent actual trading and may not reflect the impact that economic and market factors might have had on decision-making if an adviser were actually managing a client's money.

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