By  on August 27, 2007

While retailers are feeling consumers penny pinch, shares of discount chains are faring better than their full-priced and upscale counterparts.

An analysis of 12 discount, off-price and big-box retailers shows the sector is lagging behind the S&P 500 year-to-date, but outperforming the overall retail sector, where rising gas and housing prices and the recent credit crunch have weighed down a consumer's ability to spend.

Wal-Mart Stores Inc., Sears Holding Corp., Ross Stores Inc., Stein Mart Inc., Family Dollar Stores Inc. and Target Corp. all posted muted expectations for the remainder of the year — each citing, in part, macro factors.

As of market close Thursday, the group averaged a 1.1 percent decline in share price year-to-date, below the S&P 500's 3.2 percent gain during the same period, but above the S&P Retail Index's year-to-date decline of 6.1 percent.

The NPD Group chief industry analyst Marshal Cohen noted that retailers are seeing a clear disparity between lower- and upper-income shoppers for the first time in a long while — and that big-box and discount retailers' greatest challenge of late has been courting consumers who fall in between. The result is a fiercely competitive space where discount retailers have wavered focus from their core, low-income consumers, who are most impacted by rising housing and gas costs.

"It's more about conversion than attraction," said Cohen, who added retailers should take care to lure current customers into spending on a wider array of products in the store, rather than trying to attract new shoppers.

A.G. Edwards analyst Robert Buchanan said company-specific issues, negative or positive, affects company performance irrespective of the economy.

"A given retailers fate is not determined by how much wind is blowing over the lake," Buchanan said. "There is a certain amount of skill involved in maneuvering the boat."

Buchanan said retailers' better technology allows for tighter inventory and flexibility in uncertain economic times.

"They can better react to changes in demand and we're seeing that right now and that's why the earnings for the industry haven't dropped off a cliff," Buchanan said. "That said, we are in a slow period and it makes sense for retailers to plan conservatively on the inventory and expense front."Meanwhile, consumer sentiment may not be as glum as retailers expect. A recent poll by the International Council of Shopping Centers and UBS Securities found that, despite recent volatility in the financial markets, 46 percent of 1,000 consumers polled have maintained their spending habits and expressed optimism on the stock market settling. Thirteen percent said they were aware of recent stock market turmoil, but don't base their spending behavior on the markets, while 25 percent said they do not follow market reports at all.

Goldman Sachs analyst Adrianne Shapira makes the distinction between discount retailers who cater to higher-income consumers and those who market to the lowest end of the discount market. The analyst sees limited downside to both Costco Wholesale Corp. and Target, thanks to the retailers' "well-equipped" ability to weather cyclical changes based on merchandising and marketing.

"This is in sharp contrast to Family Dollar, where top-line is under pressure due to its increasingly strained low-end customer, expense pressures as management invests in long-term strategic initiatives and challenging gross margin [comparisons] as Wal-Mart becomes more aggressive on price," Shapira wrote in a note.

CL King & Assoc. analyst Mark Montagna notes that off-price retailers TJX Cos. Inc. and Ross Stores do well regardless of economic conditions.

"Both [retailers] are benefiting from the strong buying environment their buyers are finding in the market — as a result, they can both bring merchandise into the stores with favorable initial markups on a year-over-year comparison basis," Montagna told WWD. He added TJX has been particularly effective in taking advantage of the favorable buying environment.

In fact, in TJX's recent second-quarter conference call, Carol Meyrowitz, chief executive officer, said that despite gas prices impacting consumer spending, the company's first and second quarters have been indicative of performance in past, tight times.

"Macro consumer pressures have not typically impacted our business. In weak environments, new customers tend to find us, and when times improve, they usually stick with us because they love our values," Meyrowitz said. "That said, make no mistake that we prefer a strong environment — the point is that in weaker times, we tend to hold our own and do better than most."

Company (Ticker)YOY Percent ChangeYTD Percent Change
99 Cent Only Stores (NDN)5.2%-4.5%
Big Lots Inc. (BIG)49.8%16.9%
BJ’s Wholesale Club Inc. (BJ)32.5%6.4%
Costco (COST)20.5%15.2%
Dollar Tree Stores Inc. (DLTR)35%24.4%
Family Dollar Stores (FDO)14.9%-8%
Ross Stores (ROST)12%-12.9%
Sears Holding Corp. (SHLD)-0.7%-15.5%
Stein Mart Stores (SMRT)-33.3%-39.1%
Target Corp. (TGT)30.1%8.5%
TJX Companies Inc. (TJX)11.2%4.3%
Wal-Mart Stores Inc. (WMT)-1.4%-9.2%
Average Percent Change14.7%-1.1%
S&P 50013.1%3.2%
S&P Retail Index9.5%-6.1%

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