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Retailing involves buying large quantities of goods and selling them in smaller measures for a profit. The health of the retail industry is an important economic indicator as it is linked directly to consumers and their propensity to spend. Consumer spending holds the key to the well-being of the U.S. market as it accounts for more than two-thirds of economic activity.

The link between consumer spending and the retail industry becomes more relevant as retail sales attract approximately 30% of total consumer spending in the U.S. Also, the retail industry ranks among the top U.S. industries and employs an enormous workforce, thereby deciding the health of the job market.

Before jumping on to the trends in retail, here’s a peek into the key economic indicators, which suggest where the market is heading.

On the whole, the U.S. economy seems to be in good shape. Per the ‘third’ estimate released by the Bureau of Economic Analysis on Jun 29, 2017, the U.S. economy expanded at an annual rate of 1.4% in the first quarter. This marks an increase from the ‘second’ estimate of 1.2% but a downside from 2.1% growth in the fourth quarter of 2016.

While GDP growth in the first quarter was on the low side, many key parts of the economy have consistently been on the growth trajectory. Steady labor and housing markets stand witness to this. Wages have been improving as well. This is propping up the household sector’s buying power, which is showing up in revived consumer spending and consumer confidence data.

Evidently, consumer spending made a comeback in June, rising 1.1%. While this marked the weakest reading since second quarter 2013, it nearly doubled from a 0.6% rise in May. Consumer confidence improved moderately during the month of June indicating that the economy is on a recovery path after a dismal show in May. According to the recent Conference Board data, the Consumer Confidence Index rose to 118.9 in June from May’s reading of 117.6. We expect this positive sentiment to translate into higher consumer spending that may help revive sales.

Changing Retail Landscape

The Retail sector fully lives up to the saying, “The only thing that is constant is change.” This landscape has evolved from a marketplace where goods are bought and sold to a forum with multiple avenues to engage customers. With the advent of technology, the face of retail has changed from small/big retail outlets to omni-channel stores, where one can check products/prices online and buy in stores, and vice versa. Today, the success mantra in retail hovers around finding new ways to market their products.

To put it simply, the retail sector is on transformation mode – with store-based retailers now ditching their traditional stores and embracing omni-channel concepts, which provide a more seamless shopping experience both online and in-stores. The result is, customers can use computers, smartphones or tablets for shopping or visit a store if they want to.

Parallel to this shifting retail landscape, the industry is facing major challenges from a strong U.S. dollar, volatile commodity costs and global uncertainty. The volatility in the U.S. dollar has been hurting retailers with worldwide operations.  Also, the competitive situation continues to worsen as industry players vie for the top spot, focusing on speedy deliveries and enhanced customer experience, while battling margin pressures.

Key Retail Metrics

The key data in retail industry analysis is comparable-store sales (comps) as they exclude sales at newly opened and closed stores. We observe that sales data for the month of June was more or less negative, as the majority of retailers that report monthly comps faltered. With many retailers having discounted the practice of reporting monthly comps, we only have a six of them providing this key metric for June.

The list of gainers in June had warehouse retailer Costco Wholesale Corp. (COST - Free Report) on the top. The company posted a 6% rise in comps, while total sales rose 7% to $12.17 billion. Excluding the impact of foreign currency fluctuations and gasoline prices, Costco’s comps for the month under review rose 6.5%.

Right behind was Washington-based retailer of sports-related teen apparel Zumiez Inc. (ZUMZ - Free Report) that reported a 5.3% increase in comps, with sales improving 8.4% to $72.2 million from the year-ago period. Following the better-than-expected sales results for June, the company raised its guidance for second-quarter fiscal 2017.

On the other hand, apparel and accessories retailer Cato Corporation disappointed the most witha 16% decline in comps and a 15% fall in sales to $74.7 million. We note that the company’s comps have been declining for more than a year, primarily due to a tough apparel retail scenario.

This was followed by specialty retailer of women’s intimate and other apparel, beauty and personal care products, L Brands Inc. (LB - Free Report) . The company posted a comps decline of 9% while sales dropped 6% to $1.213 billion. This marked the company’s seventh straight month of comps decline. Further, the company expects comps to decline by mid-single-digits in the month of July.

Going down the line, The Buckle Inc. (BKE - Free Report) continued with sluggish comps for the sixth straight time, reporting a 5.8% decline in comps and a 5.9% fall in net sales to $73.6 million for June. Placed further down in the list is discount store operator Fred's Inc. (FRED - Free Report) which saw a 1.6% fall in comps for June. Fred's net sales slipped 5.3% to $197.5 million.

Retail/Wholesale Sector – A Mixed Bag

The Retail and Wholesale is more of a mixed bag when it comes to its performance trend. The sector has outperformed the broader market in the past six months. In the said time frame, the sector has surged approximately 10.8%, while the S&P 500 index has advanced 6.8%.

Looking at the sector’s trailing 12-month price-to-earnings (P/E) ratio, which is the most reliable multiple to value retail stocks, it looks pretty overvalued, when compared with the S&P 500. The sector has a trailing 12-month P/E ratio of 26.70, which is above the median level of 25.46 and below the high of 26.97, scaled in the past year.

However, this space compares unfavorably with the market at large, as the trailing 12-month P/E for the S&P 500 is at 20.19 and the median level is 19.49. The Retail and Wholesale sector’s stretched valuation shows that there is only little upside left for the space when compared with the S&P 500 market index.

The group’s Zacks Sector Rank confirms this view. This 236-company sector has seen seven positive and four negative revisions in earnings estimates in the recent past. It carries a Zacks Sector Rank of #15, placing it at the bottom 6% of the Zacks Rank sectors.

Zacks Industry Rank – Negative

Within the Zacks Industry classification, retailers are broadly grouped in the retail and Wholesale sector (one of the 16 Zacks sectors) and are further sub-divided into 18 industries at the expanded (aka “X”) level -- Retail–Computer Hardware, Retail–Home Furnishings, Retail–Discount Stores, Automotive–Retail and Wholesale–Parts, Retail–Mail Order, Building Products–Retail, Automotive–Retail and Wholesale, Retail–Restaurants, Retail–Consumer Electronics, Retail–Jewelry, Internet – Commerce, Retail–Apparel and Shoes, Food–Natural Foods Products, Retail–Pharmacies and Drug Stores, Retail–Miscellaneous, Retail–Supermarkets, Retail–Convenience Stores, and Retail–Regional Department Stores.

We rank all the 250 plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies. We put our X industries into two groups: the top half (industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank). Over the last 10 years, using a one week rebalance, the top half beat the bottom half by more than twice as much. To learn more visit: About Zacks Industry Rank.

The Zacks Industry Rank is #11 for Retail–Consumer Electronics (top 4%), #41 for Internet – Commerce (top 16%), #62 for Retail–Supermarkets (top 24%), #86 for Retail–Discount Stores (top 34%), #122 for Retail–Computer Hardware (top 48%), #122 for Retail–Regional Department Stores (top 48%), #122 for Retail–Home Furnishings (top 48%), #159 for Retail–Restaurants (bottom 38%), #168 for Building Products–Retail (bottom 34%), #177 for Retail–Miscellaneous (bottom 31%), #195 for Retail–Mail Order (bottom 24%), #218 for Retail–Pharmacies and Drug Stores (bottom 15%), #225 for Food–Natural Foods Products (bottom 12%), #230 for Automotive–Retail and Wholesale (bottom 10%), #237 for Retail–Apparel and Shoes (bottom 7%), #246 for Retail–Jewelry (bottom 4%), #253 for Retail–Convenience Stores (bottom 1%), and #256 for Automotive–Retail and Wholesale–Parts (bottom 1%).

On analyzing the Zacks Industry Rank for the constituent industries in this space, it is apparent that the overall outlook for the Retail and Wholesale sector is Negative.

Sector Level Earnings Trends

The Q2 earnings season (meaning June-end quarter results) is yet to unfold. However, quarterly reports from companies with fiscal quarters ending in May are coming up over the last few weeks and all these form part of the Q2 tally.

Looking at the second quarter, we note that estimates have come down, but the magnitude of negative revisions compares favorably with other periods.

As of Jul 7, we have seen results from 23 S&P 500 members, accounting for 4.6% of the index’s total membership. Of these, approximately 82.6% have delivered positive earnings surprises, while 87% beat top-line expectations. Total earnings for these index members were up 26.1% from the year-ago quarter, while revenues increased 8.3%. These early results, however, provide no basis to draw any conclusion about the quarter on the whole.

For Q2 as a whole, total earnings are expected to be up 5.8% on a 4.5% increase in revenues. This will follow 13.3% earnings growth and 7% revenue upside registered in first-quarter 2017, marking the highest growth pace in almost two years.

Coming to the retail sector, 14.3% of retailers in the S&P 500 index that combined account for 10% of the sector’s total market cap in the index have reported earnings so far. Of these, 66.7% of the members posted earnings beats and about 66.7% surpassed revenue estimates.

Combing results on board and upcoming, earnings for the Retail sector are expected to decline 0.4% in Q2, with revenues anticipated to grow nearly 3.8%.

For more details on earnings of this sector and others, please read our ‘Earnings Preview’ report.

Retail Stocks Worth Buying Now

The Retail sector may seem to be mature at the moment with little upside left. However, there are gainers in this space too that might be solid investment bets. Here are a few stocks that have been witnessing positive estimate revisions and sport a Zacks Rank #1 (Strong Buy):

(You can see the complete list of today’s Zacks #1 Rank stocks here.)

Alibaba Group Holdings Ltd. (BABA - Free Report) : The stock gained a whopping 50.4% in the last six months. Earnings estimates for the current fiscal year were revised 11.2% upward over the last 30 days. Also, the stock surpassed estimates by an average 20.5% in the trailing four quarters and has a long-term EPS growth rate of 30.4%.

Dave & Buster's Entertainment, Inc. (PLAY - Free Report) : The stock saw 6.6% upward revision in earnings estimates for the current fiscal year in the last 60 days. Also, the company delivered an average positive earnings surprise of 30.5% in the trailing four quarters. The stock has gained over 17% in the last six months and has a long-term EPS growth rate of 16.5%.

Red Robin Gourmet Burgers, Inc. (RRGB - Free Report) : The stock gained nearly 37.2% in the last six months. It has seen earnings estimates for the current fiscal year being revised 3 cents upward in the last seven days and delivered an average positive surprise of 17.3% in the trailing four quarters. The company has a long-term EPS growth rate of 10.3%.

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