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Despite the apparent values in retail stocks, there are few reasons to get excited about the retailers. Consumer spending will remain subdued for the next few quarters, and that will lead to retailers earnings estimates declining for the next several months.
The holidays are right around the corner. This is the most important period for retailers, as many generate about half of their annual sales during the holiday shopping season. The way things are shaping up, this may be one of the worst holiday shopping seasons in recent memory. Economic data from this summer suggest that consumer spending may have turned negative in the third quarter, which means the consumer was in a tough spot before the credit crunch turned into a full blown crisis.
The problems in the credit markets will only exacerbate the problems negatively affecting consumer spending. As a result, earnings estimates for retailers will continue to decline as we head into the retailers most important shopping season of the year.
After the holidays, retailers will continue to see their results suffer from the de-leveraging of the financial system. Consumers no longer have easy access to the credit markets. As the old saw goes, the only people that can borrow money today are those who dont need it. Funds for mortgages, car loans, student loans and even credit cards are becoming increasingly hard to come by for many consumers.
This situation has also made it harder for consumers to refinance existing debts. For that reason, consumers are being forced to save more to pay off debt, which reduces consumer spending. Given the historically high levels of household debt in the U.S., it will take more than a few quarters for consumers to work through this de-leveraging process.
The S&P Retail Index [RLX] is down over 30% in the last month, due to the credit crisis and worsening retail sales. Given the speed and severity of the decline in stock prices, the RLX is poised for a trading rally that could last a few days or weeks. We saw a similar rally in retail stocks off the July lows, when the RLX jumped 30% in 39 trading days. In this scenario, retail stocks across the board should spike higher.
For those looking for longer term exposure to the retailers, the more defensive plays should outperform. These include mass merchants and grocers. We have buy ratings on Kroger ([url=http://www.zacks.com/research/report.php?t=kr]KR[/url]) and Safeway ([url=http://www.zacks.com/research/report.php?t=swy]SWY[/url]). The stocks are down 15% and 21%, respectively, in the last month, even though sales at these stores should hold up better than in other areas of retail as consumers tighten their belts.
An overlooked but important consequence of this de-leveraging process is that consumer attitudes toward spending are changing. Being forced to increase savings and pay down debt, consumers have become more frugal in their shopping habits. This includes trading down from more expensive retailers to discount stores, foregoing brand name products for private labels, and rejecting the urge to "keep up with the Joneses."
And with unemployment rising and economic growth slowing, consumers will continue to tighten their belts throughout 2009. This will cause retailers to retrench further next year by closing stores, reducing inventory levels and looking for additional ways to cut costs.
During this cycle, the weaker retailers with stores that are too narrowly focused, poorly-run, or rely on the credit markets to operate will not make it. We would avoid retailers such as Cost Plus ([url=http://www.zacks.com/research/report.php?t=cpwm]CPWM[/url]) and Overstock.com ([url=http://www.zacks.com/research/report.php?t=ostk]OSTK[/url]) that were unprofitable when consumer spending trends were much stronger than they are today.