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3 Retail Stocks That Are Too Cheap to Ignore

By John Ballard - Jun 27, 2019 at 8:18AM

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These retailers are growing revenue and profits, but the stocks have been forgotten.

Retail stocks have dramatically underperformed the broader market over the past five years. The S&P 500 is up about 49%, while SPDR S&P Retail, which tracks all the retail stocks in the index, is down 3.8%. 

Some retail stocks are struggling and are down for good reasons, but there are gems to be found. Three retailers that are posting growth in comparable-store sales and generating healthy profits on the bottom line are Williams-Sonoma ( WSM -4.09% ), Foot Locker ( FL -4.17% ), and American Eagle Outfitters ( AEO -3.64% ).

What's more, these three stocks have forward price-to-earnings ratios of less than 15 and pay above-average dividend yields. 

A crowd of people walking down a street, some holding shopping bags.

IMAGE SOURCE: GETTY IMAGES.

Expanding in the fragmented home-furnishings market

Williams-Sonoma was founded in 1956 to sell high-quality cookware, but over the years the company has expanded beyond the kitchen to providing home furnishings through its subsidiaries, including Pottery Barn, West Elm, PBteen, Rejuvenation, Mark and Graham, and Outward. The stock is down 12% over the past five years, even as revenue and earnings per share climbed 26% and 42%, respectively. 

The company is off to a strong start to the year, with comps up 3.5% and EPS up 21% year over year in the last quarter. Management has made effective use of cross-promoting its brands, which has helped with customer acquisition. 

Most importantly, cross-brand customers spend an average of four times more than single-brand customers and account for 30% of the total customer base. Management believes it can continue to drive growth in the short term by continuing to cross-promote its brands, as well as improving the customer experience, bettering operational efficiency, and growing its new business-to-business division. 

For guidance, management calls for full-year EPS to be between $4.55 and $4.75, with revenue up between 2% and 5% over last year. The stock trades for a forward P/E of 13.4 and pays a 2.82% dividend yield. 

Riding the growth in sneaker sales

Foot Locker is a similar story. The stock has gone nowhere for five years, but the business continues to show growth in revenue and profits. The stock is downright cheap at only 8.4 times this year's earnings estimates. 

Some investors are concerned about where Foot Locker fits in an industry that's going increasingly digital. For example, Nike, Foot Locker's largest supplier, has invested in digital apps to sell sneakers directly to consumers, and that digital channel has been driving strong growth for the sneaker giant. 

However, Foot Locker reported growth in store-channel comps of 2.9% last quarter, while the digital channel increased by 14.8% year over year. Store traffic was down, but combined with the digital channel, overall traffic was up for the quarter. Clearly, something is going for the specialty retailer that market participants are missing.

What investors may be overlooking is that Foot Locker is an important marketing partner for both Nike and Adidas. The athletic-wear giants work with Foot Locker to develop marketing campaigns and other services to deepen customer connections with their respective brands. Last year, Foot Locker generated $7.9 billion in sales, and Nike supplies about two-thirds of the retailer's merchandise, which means Foot Locker helps move billions of dollars' worth of product for Nike every year.

Obviously, a weak-performing Foot Locker would hurt Nike's business, which gives the Swoosh incentive to bolster sales at its retail partners.

The company's recent performance certainly doesn't jibe with a P/E multiple below 10. In the first quarter, total comp sales were up 4.6%, driven by growth across all regions around the world. Through 2023, Foot Locker is targeting mid-single-digit growth on the top line while expanding the operating margin to the low double digits. 

This looks like a very undervalued retail stock, and the best thing is that investors get paid while they wait, with a current dividend yield of 3.38%. 

A consistent apparel brand

American Eagle has performed well in recent years, despite the declines in mall traffic and the impact of having Amazon.com gain share in the apparel market. The company just reported its 17th consecutive quarter of positive comp store sales. Management credits its recent performance to increasing market share in the jeans business -- American Eagle is the No. 2 jeans brand overall -- as well as the Aerie brand's success in taking share away from other lingerie stores, including L Brands' Victoria's Secret. 

What's more, American Eagle was an early investor in e-commerce and now has a $1 billion-plus digital business, and "it's growing rapidly," management says. The company continues to push forward with upgrades to the digital channel and improvements to the in-store shopping experience, all which management credits for recent growth.

Analysts expect the company to increase EPS by at least 8% over the next two years. Based on those expectations, the stock's forward P/E of 10.7 times this year's earnings estimate looks cheap. To sweeten the deal, investors also get a dividend yield of 3.11%. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

American Eagle Outfitters, Inc. Stock Quote
American Eagle Outfitters, Inc.
AEO
$25.95 (-3.64%) $0.98
Foot Locker, Inc. Stock Quote
Foot Locker, Inc.
FL
$45.96 (-4.17%) $-2.00
Williams-Sonoma, Inc. Stock Quote
Williams-Sonoma, Inc.
WSM
$197.56 (-4.09%) $-8.44

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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