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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 United States. 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 sneak peek into the key economic indicators, which suggest where the market is heading.

On the whole, the U.S. economy is picking up pace. The economic backdrop remains positive with the stock markets surging for most of the past year, wages improving gradually, the unemployment rate at a 17-year low, home prices rising and inflation remaining modest. These factors have changed consumers’ outlook, resulting in more spending as they have more money in their pockets.

This is well reflected in the 0.4% or $54.2 billion increase in consumer spending recorded in December, following a gain of 0.8% in November. Further, recent reports indicate that the optimism that built up during the holiday season has carried into January as consumers are no longer wary of shopping and the economy is taking the road uphill.

These positives led to a further rise in consumer confidence, which gauges consumers’ optimism on the economy expressed through savings and spending patterns. Per the Conference Board, Consumer Confidence Index showed a marked improvement in January, after witnessing a setback in December. Consumer Confidence rose 2.3 points to 125.4 in January, following a decline to 122.1 in December. Notably, the index rose to 129.5 in November — the highest mark since the increase to 132.6 recorded in November 2000.

The primary reason for the surge in the index is consumers’ belief that the pace of growth witnessed in the latter half of 2017 will continue in 2018. This has led consumers to use their savings to make purchases. Notably, U.S. personal savings were 351.6 billion in December, reflecting a decline from $365.1 billion in November. The savings rate dipped to 2.4% of disposable income from 2.5% in November.

Moreover, savings for 2017 declined to $485.8 billion (from $680.6 billion in 2016), with the savings rate declining to the decade lowest of 3.4%.

The low savings rate led to a rise in imports, brining about a slowdown in economic growth for the fourth quarter. Per the ‘Advance’ estimate released by the Bureau of Economic Analysis on Jan 26, 2018, the U.S. economy expanded at an annual rate of 2.6% in the fourth quarter compared with the 3.2% growth in the third quarter of 2017. However, the economy grew 2.3% in 2017, speeding up from 1.5% in 2016.

Looking at the broader picture, retailers have been the primary beneficiaries of the recent surge in consumer spending and the uplift of consumer confidence. This was evident from the splendid sales results of retailers in the holiday season. This has turned the tide of the sector, which had been struggling due to soft store traffic and the rise of e-commerce. Moreover, trends witnessed in the holiday season have continued into 2018, making us optimistic about the performance of retailers in 2018.

National Retail Federation (“NRF”) recently revealed that retail sales for January remained as strong as the holiday season. Retail sales in January rose 5.4% year over year following a 5.1% unadjusted year-over-year growth in holiday sales during November and December.

With consumers feeling good about their financial health and consumer spending reflecting steady growth, NRF predicts retail sales for 2018 to improve between 3.8% and 4.4% from the 2017 level. Notably, retail sales were up 3.9% in 2017 from 2016. Further, online and other non-store sales are likely to witness growth of 10-12% as the definition of retailing continues to evolve.

Retail Sector Poised for Growth

The Retail sector has been witness to some grave changes in 2017. The sector has evolved as a segment where buying and selling is now not restricted to stores alone. The sector now fully lives up to the mantra “Everything Everywhere,” in the real sense.

On the face of it, the sector may seem to be an Amazon (AMZN - Free Report) -dominated space, as the company continues to enter every retail category. Moreover, the retail sector has seen some big surprises in 2017, whether store closures, bankruptcies or acquisitions. In fact, it has seen the highest level of consolidation in recent times. However, the trends following the holiday season have been encouraging, with sales picking up and new trends emerging.

The recent trends in retail reveal that the sector has become a hub of innovative ideas to create fabulous consumer experiences. To be successful in the current scenario, retailers have to be ready to deliver on consumers’ shopping preferences and behaviors, which are not static.

Retailers are scrambling for ways to convert a prospective consumer into a buyer. To do this, brick-and-mortar retailers are increasingly investing in emerging technologies, including social commerce, e-commerce point of sale, face recognition techniques and virtual reality, all of which are likely to change consumers’ retail experience.

Further, the companies in the space are optimizing supply chain operations to bridge the gap between demand and delivery. Consequently, retailers are investing in advanced technologies to optimize value chain and retail market share. Today, consumers are on the lookout for convenience, personalization, speed, reasonable price, choice and quality. Though this has bestowed a great challenge on retailers, it also provides opportunities to take more risks and be more innovative.

Key Retail Metrics

The key data in retail industry analysis is comparable-store sales (comps) as it excludes sales at newly opened and closed stores. We observe that sales data for the month of January has been encouraging as the aforementioned favorable trends continue to aid top-line growth. Further, most retailers have perked up their expectations following solid comps results. With many retailers having discounted the practice of reporting monthly comps, we only have five of them providing this key metric for January.

The list of gainers for January had specialty retailer of women’s intimate and other apparel, beauty and personal care products, L Brands Inc. (LB - Free Report) on the top. The company posted comps growth of 7% while sales surged 29.2% to $1,040 million. This marked stellar growth following the 1% increase witnessed in December.

Right behind was Washington-based retailer of sports-related teen apparel Zumiez Inc. (ZUMZ - Free Report) . The company reported a 6.3% increase in comps, with sales improving 33.6% to $66 million from the year-ago period. This was the company’s 11th straight month of comps growth.

This was followed by warehouse retailer Costco Wholesale Corp. (COST - Free Report) that posted a 6% rise in comps for January, while total sales rose 8.4% to $12.24 billion. This reflects continued comps and sales growth since January 2017. Comparable e-commerce sales for the month of January surged 34.8%.

At the bottom of the pile, we have The Buckle Inc. (BKE - Free Report) , which reported a 0.2% increase in comps, following a 4.1% decline in December. Further, net sales rose 27.1% to $55.7 million for January.

Lagging behind, apparel and accessories retailer Cato Corp. continued with its dismal comps trend. Comps for January declined 6%, while sales rose 19% to $45.5 million. We note that the company’s comps have been declining for more than a year, primarily due to a tough apparel retail scenario.

Retail/Wholesale Sector – Steady Growth, Valuation Stretched

The Retail and Wholesale is displaying steady growth as is reflected by its performance trend. The sector has outperformed the broader market in the past year. In the said time frame, the sector has surged approximately 31%, while the S&P 500 index has advanced 16.5%.

The group’s Zacks Sector Rank shows further optimism. This 218-company sector has seen 110 positive and 62 negative revisions in earnings estimates in the recent past. It carries a Zacks Sector Rank of 2 (out of 16), placing it at the top 13% of the Zacks Rank sectors.

However, a look at the sector’s trailing 12-month price-to-earnings (P/E) ratio, which is the most reliable multiple to value retail stocks, shows that it is pretty overvalued compared with the S&P 500. The sector has a trailing 12-month P/E ratio of 30.5, which is above the median level of 27.1.

This reflects an unfavorable comparison with the market at large, as the trailing 12-month P/E for the S&P 500 is at 21.3 and the median level is 20.1. 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.

Zacks Industry Rank – Positive

Within the Zacks Industry classification, retailers are broadly grouped under 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, Retail – Catalog Shopping, 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 #2 for Automotive–Retail and Wholesale (top 1%), #3 for Retail–Regional Department Stores (top 1%), #5 for Retail–Consumer Electronics (top 2%), #12 for Retail–Miscellaneous (top 5%), #22 for Retail–Discount Stores (top 9%), #33 for Automotive–Retail and Wholesale–Parts (top 13%), #37 for Retail–Computer Hardware (top 14%), #58 for Retail–Home Furnishings (top 23%), #75 for Retail–Apparel and Shoes (top 29%), #83 for Building Products–Retail (top 32%), #86 for Retail–Mail Order (top 34%), #91 for Retail–Restaurants (top 36%), #116 for Food–Natural Foods Products (top 45%), #133 for Internet – Commerce (bottom 48%), #133 for Retail–Pharmacies and Drug Stores (bottom 48%), #133 for Retail–Supermarkets (bottom 48%), #133 for Retail – Catalog Shopping (bottom 48%), #236 for Retail–Jewelry (bottom 8%), and #236 for Retail–Convenience Stores (bottom 8%).

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 Positive.

Sector Level Earnings Trends

The Q4 earnings season (meaning December-end quarter results) is materially behind us. While majority of the sectors are done with this reporting cycle, we still have reports coming mostly from the retail sector. The Q4 earnings season is tracking to be fabulous in all ways. The quarter clearly points to momentum both for revenues and earnings. The quarter has witnessed an above-average proportion of positive surprises and upward estimate revisions.

Notably, first-quarter 2018 estimates have been going up significantly since mid-December. The first-quarter estimates for 13 of the 16 Zacks sectors have been rising invariably, with only the Conglomerates, Autos and Consumer Staples sectors witnessing a downtrend. Further, we note that the positive estimate revisions trend is not only confining to the first quarter but also for the following quarters and full-year 2018.

As of Feb 16, we have seen results from 398 S&P 500 members, with total earnings for these index members already up 14.5% from the year-ago quarter, and revenues increasing 9%. Of these, approximately 77.9% have delivered positive earnings surprises, while 75.6% beat top-line expectations. The blended beat ratio (companies beating both earnings and revenues) has so far been 62.1%.

For Q4 as a whole, total earnings are expected to be up 14% on an 8.2% increase in revenues. This will follow 6.7% earnings growth and 5.8% revenue upside registered in third-quarter 2017.

Undoubtedly, the fourth-quarter earnings season is on track to be among the best in recent quarters. The results are better not only in terms of enhanced growth from the same group of 398 index members, but also a greater proportion beating top and bottom-line estimates.

Coming to the retail sector, 18 of the 39 retailers in the S&P 500 index have reported earnings so far. Of these, 72.2% of the members posted earnings beat and about 77.8% surpassed revenue estimates. Total earnings for these companies were up 13.1%, on 14.6% revenue growth.

Combining results on board and upcoming, earnings for the Retail sector are expected to improve 7.3% in Q4, with revenues anticipated to grow nearly 9%.
For more details on earnings of this sector and others, please read our ‘Earnings Preview’ report.

Retail Stocks Worth Buying Now

The Retail sector seems to be booming with a stable economy and robust consumer spending and confidence. Thus, we bring you some gainers from the space that may prove to be lucrative investment options. Here are a few stocks that have been witnessing positive estimate revisions and carry a Zacks Rank #1 (Strong Buy) or 2 (Buy):

Autonation Inc. (AN - Free Report) : The stock gained a solid 24.7% in the last six months. Earnings estimates for the current fiscal year were revised 9.9% upward in the last 30 days. Also, the stock surpassed estimates by an average 8.5% in the trailing four quarters and has a long-term EPS growth rate of 8.5%. The stock currently has a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.

Target Corporation (TGT - Free Report) : The company saw nearly 4.2% 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 10.2% in the trailing four quarters. This Zacks Rank #1 stock has gained 35% in the last three months and has a long-term EPS growth rate of 4%.

Restoration Hardware Holdings Inc. (RH - Free Report) : The stock gained a whopping 96% in the last six months. It has seen earnings estimates for the current fiscal year being revised 1 cent upward in the last 60 days and an average positive surprise of nearly 17% for the trailing four quarters. The company has a long-term EPS growth rate of 20% and sports a Zacks Rank #1.

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