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The retail sector has struggled recently as a number of high profile operators have presented cautious guidance for the second half of 2013.  Target (TGT - Analyst Report), Wal-Mart (WMT - Analyst Report), Nordstrom (JWN - Analyst Report), and Macy’s (M - Analyst Report) have been a few household names that have cooled investor enthusiasm toward the retail sector and the economy.   Their performance has proposed two questions:  1) Is the retail sector seeing meaningful deterioration?  2) What companies in the retail space present an investment opportunity? Let's answer these questions.

Retailers have contributed to souring investor sentiment:

Besides Fed taper talk (which is getting old), the conservative comments from retailers have played a role in souring investor enthusiasm.  The American Association of Individual Investor survey of bullish sentiment fell to 29 in the week ending August 22nd down from a July 11th peak of 48.9.  The indicator is the lowest since April and just below levels seen during the June sell off. From a contrary standpoint, the reduction in bullish sentiment is a favorable factor for future price gains.

Retail stocks have declined:

Since August 5th, the SPDR Retail ETF (XRT) has declined about 5.5% from the high.  The correction put a dark cloud over the equity market, as the retail sector has been a market leader in 2013.  It tends to be a coincidental to leading indicator of the overall market.

Some retailers suggest back to school is ok:

Despite caution with the forecast, Kohl’s (KSS) seemed pleased with early August sales, and Macy’s indicated it was encouraged by early August traffic.  The comments from Kohl’s and Macy’s create some conflict over the weak guidance in the sector and argue for a look at the trend in sales.

The graphic below benchmarks weekly chain store sales since 2008 from the 29th week of the year (about mid-July) through the 37th week of the year (just after Labor Day).   The graphic is an attempt to game this year’s back to school activity relative to recent years. The two thick lines represent the maximum and minimum values, while the thin dashed line is the five year average (2008 to 2012).  The line with the squares representing the data points is 2013.

So far, activity is running at to near the average of recent years.  There is nothing unusual in the recent sales trend.  The results seem to question the caution, but also confirm the comments from Kohl’s and Macy’s suggesting that early August activity is trending at an acceptable rate.   The recent drop in gasoline prices and low level of unemployment claims may be providing balance to sluggish wage growth, reduced refinance activity, and still high unemployment.

Negative sentiment toward the economy may be rising:

One of the drivers of caution among retail management may be unease about the health of the labor market.  Gallup has gotten into the business of running a poll on unemployment.  The survey has recently shown a material increase in unemployment.   The survey may be confirming news stories highlighting layoffs at Wells Fargo’s (WFC - Analyst Report) mortgage unit and news of United Parcel Service (UPS - Analyst Report) eliminating healthcare benefits for spouses.  The Gallup survey is based on a 30 day rolling average of responses.  The survey results diverge with the recent drop in unemployment claims, but may get more attention if weakness shows up in more traditional economic indicators.

Where to shop:

With EPS estimates under pressure in the retail sector, it is probably best to look for names which have provided stable to firm guidance and are able to service a niche.  Here are three suggestions:

Children’s Place (PLCE - Snapshot Report).  This is a Zacks Rank #2 (Buy) which reported robust profits and raised Q3 EPS guidance to $1.83 to $1.89 against a Zacks Consensus EPS Estimate of $1.79. This is a specialty retailers operating in children’s apparel.  The stock was reasonably priced at 15.1 times forward earnings before it bumped up earnings guidance.

Michael Kors (KORS - Analyst Report), Zacks Rank #1 (Strong Buy), raised its FY 2014 EPS guidance when it released earnings in early August.  The FY 2014 Zacks Consensus EPS Estimate has jumped $0.19 to $2.76 in the past 30 days.  It operates in the high end or luxury retail market.  Its customers are likely to be least impacted by a sudden rise in the unemployment rate.  One attractive feature of KORS rests in its PEG ratio which is 0.92 against a 10 year median of 1.05.  The company is priced just below its growth rate and has a combined value and rising earnings growth story.

Best Buy (BBY - Analyst Report), Zacks Rank #2 (Buy), reported a 166% earnings surprise when its reported earnings for the quarter end July earlier this month.  The electronics space is competitive, but the company seems to be on a turnaround path. Consensus FY 2015 EPS estimates have increased $0.06 to $2.46 over the past 30 days highlighting the improved outlook.  It may provide a way to play electronics demand into the holiday period.  The stock seems to have an attractive valuation at 14.4 times 12 month forward earnings per share estimates.  The 10 year median is 16.5.

Concluding thoughts:

The outlook for retail will become clearer when back to school sales are finally tallied and August retail sales are released September 13th.  Weekly chain store sales suggest it is business as usual in the sector, but Gallup is warning of material weakness in the labor market not inconsistent with retail managers trying to lower the bar for exceeding profit estimates.  For those investors looking to put cash to work in the retail sector, children’s Place, Michael Kors, and Best Buy may provide a place to shop.

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