U.S. retail sales rose 5.1% to $850 billion during last year's holiday shopping season, marking the industry's strongest growth in six years, according to Mastercard SpendingPulse. This indicates that the "retail apocalypse" didn't crush all retailers, and those left standing still have room to run.
The "fun" discount retailer
Leo Sun (Five Below): Five Below carved out a high-growth niche by applying a discount retailer business model to "fun" stores for teens and young adults. Its stores -- which sell a wide range of toys, games, clothing, accessories, and snacks at $5 and under -- are mostly located in malls in college towns.
Five Below finished last quarter with 745 stores, but it plans to expand its store count to 2,020 locations by 2020 and over 2,500 locations over the long term. The bears once criticized Five Below for relying too heavily on new-store openings to boost its top-line growth, but its comparable-store sales have also been rising at a healthy rate.
The company recently reported that its holiday sales rose 25% annually with 5% comps growth. For the full fourth quarter, which ends on Feb. 3, it expects its revenue to rise 17%-19% and for its comps to improve 3%-4%. Analysts expect Five Below's revenue and earnings to go up 22% and 49%, respectively, for the full year.
Five Below's growth figures are impressive for a brick-and-mortar retailer mostly based in malls. However, the stock isn't cheap at 40 times forward earnings, and rising tariffs on Chinese goods could weigh down its margins. Nonetheless, I think Five Below's growth remains in the early innings, and its long-term expansion plans could plant the seeds for multibagger returns.
A second chance for a great deal
Jamal Carnette, CFA (Target): In 2017, I predicted Target would have a great 2018 based on cheap valuations and operational improvements, mainly in digital sales. Until October, my analysis looked prescient, as the company rocketed 30% higher, before the end-of-the year market sell-off erased all gains. While the company outperformed the greater S&P 500 last year, it wasn't what shareholders were looking for.
However, Target has provided investors strong top-line results: Throughout the first three quarters, it has reported same-store sales growth of 3%, 6.5%, and 5.1%, respectively, due to strong digital sales. Last quarter, e-commerce sales grew 49% year over year.
It's not all good news for Target, though. The trade-off for increased e-commerce sales is lower margins, both on account of increased shipping costs and easier cost comparisons. Shares sold off nearly 10% after the third-quarter earnings report a as 90-basis-point decrease in gross margin -- from 29.6% to 28.7% -- made the retailer miss bottom-line expectations.
As a result, Target remains cheap by traditional metrics: a forward price-to-earnings multiple of 13 times while paying 3.5% per year for a dividend it has increased for 47 consecutive years. While I'm concerned about margin erosion, it's more than baked into the valuations at this level. Income-hungry investors looking for bargains should put the company on its watchlist.
Winning where it counts
Demitri Kalogeropoulos (Costco): Warehouse giant Costco may trail Walmart when it comes to global sales, but it beats the retailing titan -- and everyone else -- in just about all other important operating metrics. Like many peers, the chain is enjoying record customer traffic growth lately, but its faster gains translate into consistent market share wins. Costco's latest quarter was a prime example of those trends, with a 5% spike in customer traffic powering 8% higher sales. Walmart grew at a 3% rate.
That market-beating growth came despite higher membership prices, which have allowed Costco to significantly expand its profits over the last few years at a time when Wal-Mart and Target are reporting lower operating income. But perhaps the best reason to like this business today is that its subscriber renewal rate is inching toward a record high. That shows just how much value shoppers are deriving from their annual memberships, which means Costco is in a prime position to extend its industry outperformance into 2019 and beyond.
Demitrios Kalogeropoulos owns shares of Costco Wholesale. Jamal Carnette, CFA owns shares of Target. Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Mastercard. The Motley Fool recommends Costco Wholesale and Five Below. The Motley Fool has a disclosure policy.