NEW YORK — Looking good.
That’s the attitude retail and apparel analysts have toward the stocks they cover.
Despite the roller-coaster ride felt on both Main Street and Wall Street, retail and apparel stocks are poised to fatten investors’ portfolios in the second half, as apparel companies begin to mark the anniversary of markdown-heavy performance last fall and look forward to a more fashion-driven back-to-school selling season.
In addition, observers agree, retail executives have been diligent, trimming inventories and buying closer to need, generating stellar gross margins and eking out decent profits in an economic environment that is starving for good news.
Although retail and apparel stocks have generally been on par with the broader market, taking the ride along with everyone else, David Lamer, an analyst with Ferris, Baker Watts, said: “There are a lot of good opportunities out there to buy some of these companies at these inexpensive prices. The business continues to be good and, with inventory levels being as low as they are, I think gross margins will be rescued and sales will improve in the back half of the year.”
Most industry observers agreed, calling the sector a safe haven for investors’ dollars because of the strength of business fundamentals going into the all-important second half. So while investors may be reluctant to put money in the equity market due to the recent corporate scandals at Enron, Worldcom and Adelphia, they say when they become comfortable again — and when new laws are put in place to prevent future scandals — retail and apparel stocks are a safe place to go because of their hard assets like real estate. That’s in contrast to the past, when ideas and trademarks made technology issues the darlings of Wall Street.
Lamer said his favorite picks are such stocks as Coach, Tiffany, Neiman Marcus and Nordstrom, whose prices got knocked around out of fear their customers would be hardest hit during the economic slowdown. “Coach is my favorite pick out there because its stock price has been driven down by the Street almost 33 percent in the month, but its business has been great and it is a great brand.” he said. In addition, he liked Dillard’s, calling it “the underdog,” although its business remains healthy and its gross margins continue to improve as it focuses more on private label brands.
“In uncertain times, people still need to shop, and it is a lot easier to purchase a Coach handbag than a $7,000 couch,” Lamer said.
Dana Telsey, an analyst at Bear, Stearns, agreed with the upside potential of these stocks. “Retail fundamentals are strong,” she said. “Apparel retailers are in better shape this year than they were last year — inventory levels are lean, retailers are up against easier comps than last year and margins are stronger.” Telsey said her picks of the moment include The Limited Brands, Ann Taylor and Talbots, as well as off-price retailers like Ross and TJX, both of which were able to get more brands in their stores to attract more customers.
However, the wild card this year is consumer confidence and how the public will react to dwindling stock values and the prospects for delayed retirement. Some analysts said they are waiting to see how back-to-school sales will fare before they put out any green lights to purchase stocks. But with new fashion hitting the stores, they believe there is justification for some optimism.
The cyclical nature of retail, and its dependence on the back half of the year for sales and profits, tends to depress those stocks at this time of year anyway. But add to that the weakness of retail a year ago and the upside for fashion in the months ahead and the potential for stock growth seems considerable.
Joe Teklits at First Union Securities noted stocks’ valuations are down to near their average historical low levels, meaning the downside risk to owning these names does not seem to be significant. He noted that, over the past four years, his group of specialty retailers has traded down as low as 15 times earnings and as high as 24 times. However, currently, the group is trading at 16 times earnings estimates.
Teklits said his picks are Pacific Sunwear of California, which just reported a 10.5 percent June comp gain, and Abercrombie & Fitch because it still has good growth potential.
“This is the time of year you want to own retail stocks, not trade them,” Teklits said. “Although right now, investors have some trepidation going into the fall and holiday season because of the risk of it being a bust, over the long run, getting involved with retail stocks at these lowered prices is a positive.”
Kimberly Greenberger at Lehman Bros. said that while lower interest rates helped the home and auto industries prosper following the terrorist attacks last year, the retail sector suffered major setbacks in the third and fourth quarters. Stores slashed prices to rid themselves of excess inventory, hurting profitability.
“As long as we do not have some kind of shock to the economy or double-dip recession, the consumer will likely continue to spend on smaller-price-point purchasing, including apparel, accessories and footwear, as the economic recovery comes in fits and starts,” she said. “As a result, companies can now start looking for profit growth this year, and that is attractive to the sector’s stock performance,” she said. “The hurdle is so much lower in the retail group.”