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Ah, Black Friday. Millions of Americans awake before sunup, shrug off the tryptophan hangover, and patriotically dash into the arms, err, aisles, of eager retailers. But while the masses are frantically exercising their right to consume, investors with a penchant for the discretionary sector would do better to first pause and consider.
True, some retailers' stocks look attractive this season. Others, however, likely already reflect any coming good news. And scratch the surface of a third group, and it's a lump of coal to the core.
For my take on the sector, along with some specific recommendations of where (and where not) to hang your portfolio's stocking, grab some leftovers and read on.
First, let's consider the overall economic backdrop.
On the positive side, a recent Barron's article observes that U.S. consumer debt is down by about $1 trillion, or 7.4%, from the all-time high of 2008. Also, discretionary spending as a percentage of total spending is scraping along 50-year lows, auguring a rebound. Perhaps most encouraging, consumer-initiated loan inquiries have ticked up in both of the past two quarters, indicating a renewed willingness to spend.
Finally, I'll toss in an item not mentioned by Barron's -- the wealth effect created by QE2. With the market up more than 14% since the end of August, consumers have to be loosening their purse strings, no?
OK, all this sounds cheery, especially when we lay on the National Retail Federation's call for a 2.2% rise in holiday sales. But consumer discretionary has already sprung ahead as the best-performing S&P 500 sector year to date. Has the news really been that strong? And does private equity -- hardly famous for great timing -- know what it's doing, or should the recent buyouts of Gymboree and J. Crew be taken as contrary indicators?
According to an October online poll, households with incomes of $50,000 and above will spend nearly 3% more than in 2009, versus about 1% less for those who aren't as well off. That finding is consistent with bullish forecasts for same-store luxury sales, not to mention a strong historical correlation between stock market returns and high-end retail.
Unfortunately, the market has been onto this trend for a while now. Which means we'll have to look harder to find ways to exploit it without overpaying.
Buy, window shop, or avoid?
First off, if you're looking to play this trend through the big-box retailers, Target (NYSE: TGT ) clearly outshines Wal-Mart (NYSE: WMT ) . The former saw same-store sales rise during Q3, versus a decline for behemoth Wal-Mart's U.S. locations. Plus, Target has offered investors a superior Q4 forecast, with comps seen up 2%-4%.
All said, it appears safe to conclude that Target is benefitting from its more affluent customer base. And with solid margins and a forward price-to-earnings ratio of just under 13, there's plenty of room for price appreciation.
Another closely watched area is Internet-based spending -- after all, holiday retail online sales are expected to jump 11% compared to last year. Amazon.com (Nasdaq: AMZN ) is arguably the most obvious, and the largest, beneficiary, but it's hard to get comfortable with the stock's valuation. Instead, I'd suggest investors take a look at eBay (Nasdaq: EBAY ) . The company is riding high on the growth of its PayPal unit, and its marketplace revenue could be poised for a turnaround. Plus, the shares sport a much more sober valuation.
Narrowing our retail focus, "affordable luxury" retailer Coach (NYSE: COH ) and athletic and apparel purveyor Nike (NYSE: NKE ) both make my list as beneficiaries of a wealthier-consumer spending spree. I've previously touted the merits of both companies, and I believe that long-term fundamentals remain intact.
Problem is, the shares of both have enjoyed a major run in recent months, and now trade at forward multiples north of 17. While not wildly expensive, such valuations could be the worst of both worlds -- little downside protection and limited upside potential.
Instead, investors might consider Macy's (NYSE: M ) , trading at a forward P/E of 11.5, and lifestyle retailer Guess?, changing hands at a forward multiple of 14.7. Smacked with losses during the Great Recession, Macy's clearly has a lot to prove. But third-quarter comps were up nearly 4%, and after structural changes, 40% of inventory is unique to Macy's, giving consumers a reason to walk in the door. Notably, that bargain-basement P/E allows room for investors to further warm up to shares.
As for Guess?, the company is cash-rich, virtually debt-free, boasts industry-crushing profit margins, and recently beat Q3 analyst forecasts while simultaneously raising its full-year profit estimate. Plus, the company raised its dividend 25% and announced a special payout of $2 a share. How's that for a stuffed stocking?
But one caveat
There's nothing wrong with getting excited about an upturn in certain sectors of seasonal consumer spending, and I've tried to suggest companies that are poised to outperform beyond the holiday rush. But if the stock market tumbles, the affluent consumer could once again join his poorer brethren in the bunker. In other words, make your holiday purchases with all the enthusiasm that gift-giving deserves, but buy your stocks cautiously.
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