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Are Retail ETFs Cheap Post Q1 Earnings?

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The Q1 earnings season is coming to an end, and the retail sector has been a big disappointment with a number of departmental stores like Macy’s (M - Free Report) and traditional brick-and-mortar operators like Target (TGT - Free Report) coming short of already-low estimates on a weak consumer spending environment. Sluggish results from Nordstrom (JWN - Free Report) also weighed heavily on the sector (read: Retailers Sink: Alarm Bell Ringing for ETFs as Q1 Unfolds?).

Notably, Q1 earnings from 94.6% of the sector’s total market capitalization reported so far are up 2.4% on 5.4% higher revenues with 68.4% of the companies beating on earnings and 50% exceeding the top line estimates. While growth rates are unimpressive, the beat ratios are still far better than Q4, resulting in a 0.4% negative price performance for the broad sector, as per the latest Zacks Earnings Trend report.

Earnings surprises, mainly prompted by astounding results from online e-commerce behemoth Amazon (AMZN - Free Report) and the world's largest retailer Wal-Mart (WMT - Free Report) , have given some boost to the sector. Additionally, better-than-expected earnings from retailers like Dicks Sporting Goods (DKS - Free Report) , Lowe’s (LOW - Free Report) and Home Depot (HD - Free Report) spread further optimism in the sector. While DKS and LOW shares surged following the results, HD shares fell.

Let’s dig into the details of the earnings releases:

Retail Stocks Springing Surprises

Dicks Sporting Goods emerged as the real champion in the Q1 earnings season as the stock surged 14.1% following mixed first-quarter fiscal 2016 results on May 19. While revenues came slightly below the Zacks Consensus Estimate, earnings topped our estimates by a penny. Further, the company cut its full-year earnings guidance from $2.85–$3.00 to $2.60–$2.90.

The world's largest retailer, Wal-Mart, jumped 10.6% following blockbuster first-quarter fiscal 2016 results on May 19, reflecting the biggest one-day gain in more than seven years. The company edged past our earnings estimates by 10 cents and revenue estimates by $3.2 million. Additionally, the mega retailer provided upbeat earnings per share guidance for the ongoing second quarter in the range of $0.95–$1.08; the midpoint of which was much above the Zacks Consensus Estimate of 99 cents, at the time of earnings release (read: Wal-Mart Q1 Bucks Weak Retail Trend: ETFs to Surge).

Home Depot, the world's largest home improvement retailer, cheered investors with better-than-expected fiscal Q1 results and raised guidance. The company beat on earnings by 10 cents and on revenues by $445 million. For fiscal 2016, Home Depot now expects earnings per share to increase 14.8% year over year to $6.27 compared to the previous expectation of earnings growth of 12–13% to $6.12–$6.18. However, the stock shed nearly 2.6% on the day of its earnings announcement on May 17.

The second-largest home improvement retailer, Lowe’s, topped our fiscal first-quarter earnings estimates by a couple of cents and revenue estimates by $340 million. Additionally, the company provided an upbeat guidance for fiscal 2016. The company expects sales to grow 6%, and earnings per share of $4.11. The stock gained 5% on the day of its earnings release on May 18.

The Real Dampeners

The second-largest department store retailer, Macy’s, is the major loser as the stock tumbled 15.6% to its lowest since December 2011 the day after posting a bigger-than-expected drop in quarterly sales and trimming its full-year outlook. Though the company beat the Zacks Consensus Estimate by a nickel, it fell 28.6% year over year following a 14.3% drop in the preceding quarter. Revenue also fell short of our estimate by $164 million. For fiscal 2016, the company slashed the earnings per share guidance range to $3.15–$3.40 from $3.80–$3.90. The mid-point of the new guidance was much lower than the Zacks Consensus Estimate of $3.77 at the time of the earnings release.

The specialty retailer, Nordstrom, tanked 13.8% following lackluster first-quarter fiscal 2016 results. The company missed the Zacks Consensus Estimate for earnings by 19 cents and for revenues by $44 million. In addition, the company slashed its earnings per share guidance to $2.50–$2.70 from $3.10–$3.35 for fiscal 2016, the upper-end of which was well below the Zacks Consensus Estimate of $3.17 at the time of the earnings release. Nordstrom now expects sales to increase 2.5–4.5% against the previous outlook of 3.5–5.5% growth (see: all the Consumer Discretionary ETFs here).

The big-box retailer, Target, plunged 8.9% on the day of its fiscal first-quarter 2016 earnings announcement on May 18. Though the retailer topped our estimates for earnings by nine cents, revenues missed our estimates by $113 million. Further, it disappointed investors with its downbeat guidance for the second fiscal quarter. The company guided earnings per share in the range of $1.00–$1.20 for the ongoing quarter, the midpoint of which was lower than the Zacks Consensus Estimate of $1.38 at the time of the earnings release. Target also reaffirmed its fiscal 2016 earnings per share guidance of $5.20–$5.40 for fiscal 2016; the mid-point was ahead of the Zacks Consensus Estimate of $5.27 at that time.

ETFs in Focus

The string of weak earnings offset the strong performances and led to rough trading in retail ETFs, making them cheap at current levels. Investor seeking to tap the current beaten down prices in a diversified way could consider the following three ETFs. These funds could be considered solid picks given that these have a solid Zacks ETF Rank of 1 (Strong Buy) or 2 (Buy) and retail fundamentals are improving lately (read: Retail Sales Back to Health; ETFs to Watch).

SPDR S&P Retail ETF (XRT - Free Report)

This product tracks the S&P Retail Select Industry Index, holding 99 securities in its basket. It is widely spread across each component as each of these holds less than 1.6% of total assets. Small cap stocks dominate nearly three-fifth of the portfolio while the rest have been split between the other two market cap levels. In terms of sector holdings, apparel retail takes the top spot at 21.9% share while specialty stores, automotive retail and Internet retail have a double-digit allocation each. XRT is the most popular and actively traded ETF in the retail space with AUM of about $636.4 million and average daily volume of more than 4.8 million shares. It charges 35 bps in annual fees and shed 7% over the past one month. The fund has a Zacks ETF Rank of 2.

Market Vectors Retail ETF (RTH - Free Report)

This fund tracks the MVIS US Listed Retail 25 Index and holds about 26 stocks in its basket. It is a large-cap centric fund and is heavily concentrated on the top firm – Amazon – at 15.4%, followed by Home Depot and Wal-Mart with a combined share of 15.8%. Sector wise, specialty retail occupies the top position with 29% share, followed by double-digit allocations each to Internet and catalogue retail, hypermarkets, drug stores, and health care services. The fund has amassed $133.7 million in its asset base while average daily volume is moderate at about 54,000 shares. Expense ratio came in at 0.35%. The product lost 1.8% in the same period and has a Zacks ETF Rank of 1 (read: Consumer Face Off: Wal-Mart versus Amazon ETFs).

PowerShares Retail Fund

This retail fund provides a diversified exposure across various market caps with 50% in small caps, 39% in large caps, and the rest in mid caps. This is easily done by tracking the Dynamic Retail Intellidex Index. The fund has accumulated just $18.9 million in its asset base while trades in a light volume of around 5,000 shares a day. The ETF charges 63 bps in fees per year. In total, the product holds 309 securities with each accounting for less than 5.4% of assets. In terms of industrial exposure, specialty retail takes the top spot at 53%, while food retail and drug stores round off the top three positions with 13% share each. PMR is down 4.4% in the past one-month and has a Zacks ETF Rank of 2.



Bottom Line

Investors should note that these retail funds are clearly underperforming the broader market fund by wide margins. The trend is likely to reverse in the coming days given the regained momentum in consumer spending after a slow first quarter, strong retail sales witnessed in April, rising consumer confidence, better job and wage prospects, and low oil prices.

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