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Three Stocks Worth Buying After Retail's Flop

By Nicholas Rossolillo - May 26, 2016 at 12:24PM

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The retail industry has hit a rough patch. Ignore the downbeat press and check out these companies.

Retail stocks have been under intense pressure. As measured by the S&P Retail ETF, shares of retail companies are down 12% so far this month. In certain cases, the market seems to have gotten ahead of itself. Here are three retail stocks worth buying right now.

Betting on big-box stores

Shares of Target (TGT -0.64%) are down 20% and sported a nearly 10% decline in a day after earnings on May 18. The general-merchandise juggernaut has had its fair share of scandal in recent years. The company is still in the midst of recovery from the customer credit card information theft a couple years ago and now is dealing with outrage among some shoppers against its new bathroom policy. The company downgraded profit guidance for the second quarter of 2016, and revenue was down year over year by 5%, sending many investors to the exit.

Image source: Target.

While news headlines may suggest bathroom policies are the blame for the drop in revenue, the sale of its underperforming pharmacy business last year is more likely the cause. Although revenue missed, profit came in above expectations for the quarter.

Overlooked is that the big-box store has been making great strides in modernizing its business. While Internet sales accounted for only 3% of revenue last quarter, those sales have been increasing by over 20% for almost two years now. This reflects the company's heavy investment to bring its model up to speed in the digital age, combining its physical footprint with its website to offer in-store pickup and drive traffic to the online store.

In spite of a downbeat forecast for the second quarter, management reiterated its guidance of full-year profit growth of 11% over 2015. After the sell-off, Target now trades at a discount to its closest peers. For example, its forward and trailing price to earnings sits 20% lower than that of Wal-Mart. Target also pays a dividend yielding about 3%. I think the company is currently priced at a bargain.

A strong dividend play

Department stores were hit especially hard this earnings season, and Kohl's (KSS -1.92%) was no exception. The stock is down well over 20% in a month. The reason? Sales came in much lower than anticipated, profit was squeezed by heavy discounting to reduce inventory, and expenses rose because of an uptick in wages.

Image source: Kohl's.

While some department stores have dipped into unprofitability and are closing locations, Kohl's remains a stable business and is opening new store concepts. Sales growth has been flat over the past few years, but online sales have been increasing in the mid-teens.

Kohl's has been experimenting with its new small-footprint store concept, as well as the opening of "off-aisle" stores, a discount concept that sells items that customers have returned. The outlet-mall model will also be tested with 12 new Fila stores, which will tote the exclusive product line Kohl's has in the athletic clothing space. Management sees the investments in new store concepts and its online presence taking a few years to pay off, and profit will continue to be squeezed as a result.

Despite this period of transition, management has stuck to its plan of paying a competitive dividend and sees a possible 10% increase to that dividend this year. After the steep drop in share prices, Kohl's current dividend yield is at 5.5%. For those looking for a nice dividend payout, Kohl's looks very attractive at these levels.

A specialty retailer at a bargain

While the last month hasn't seen as steep of drops for specialty shoe retailer Foot Locker (FL -4.57%), the company is trading near its 52-week low and 35% off its all-time high, even though 2015 was its sixth consecutive year posting double digit-profit growth and 2016 is getting off to a strong start.

Image source: Foot Locker.

The specialty store concept has seen a general increase in popularity, and Foot Locker has been able to capitalize on that trend. Once a struggling shopping-mall chain, the company has given itself a facelift over the past few years with trendy store remodels and multiple exclusive product lines from Nike, Under Armour, and others. The concept caught on with athletes and has helped power the company's growth higher in the past decade.

Foot Locker saw double-digit growth in online and international sales last year. Management expects the international business, especially in Europe, to lead the way higher in years to come. Other areas the company is building on are its Kids Foot Locker stores and a push into selling apparel. So far in 2016, revenue is up again in the low single digits year over year, and profits are up about 8% year over year as the growth strategy continues to yield returns.

The company increased its dividend another 10% earlier in the year and has nearly doubled the payout over the past seven years to its current yield of just under 2%. The performance-shoe chain also has over $600 million left to go on its $1 billion share-repurchase program approved over a year ago. With shares down sharply against a backdrop of steady expansion in the top and bottom line and strong growth momentum going forward, Foot Locker presents an intriguing possibility. 

Final thoughts to consider

Periods of large declines in the market, especially over a short time period as we've seen for many retail stocks this month, present a wonderful opportunity for investors to go shopping. Consumers continue to spend and have continued to increase their discretionary budget over the past few years, but spending habits are in transition. The short-term pain as businesses adjust to these changing habits spell long-term profit for those willing to see through the fog.

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Stocks Mentioned

Kohl's Corporation Stock Quote
Kohl's Corporation
$35.22 (-1.92%) $0.69
Target Corporation Stock Quote
Target Corporation
$140.99 (-0.64%) $0.91
Foot Locker, Inc. Stock Quote
Foot Locker, Inc.
$25.68 (-4.57%) $-1.23

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