U.S. consumers are reportedly getting crushed beneath massive indebtedness and soaring unemployment. Yet two of the world's greatest investors, George Soros and Berkshire Hathaway's (NYSE:BRK-A) (NYSE:BRK-B) Warren Buffett, just upped their stakes in the world's largest retailer -- Wal-Mart (NYSE:WMT).
Do they know something we don't? Is it time to start buying retail?
To examine whether the retail industry may be bouncing back, and which retailers are the best bets, I asked the investing team at Motley Fool Hidden Gems one simple question: What's your favorite retail stock?
Stan Huber, senior analyst
Retail scares me a little at present, because of the recent run-up in stock prices. That said, my favorite name in this space currently is Tractor Supply. It has a reasonable moat, a large amount of recurring business, and strong operational management. It is also still a strong growth story that scales well, and it's being funded from operating cash flow.
Tractor Supply is a niche business serving recreational farmers, ranchers, and local tradesmen in thriving rural communities. Its largest business segment is the sale of equine, pet, and animal products such as food, cages, and medicine -- a regular and recurring source of business. It also sells tools, garden equipment, clothing, and everything else you could imagine for the rural lifestyle.
The company has a focus on customer service and stocks an inventory of both brand-name products and private-label goods. It proved resilient during the recession and expects to eventually double the number of stores in its chain. This is definitely one to have on your retail radar.
Mike Olsen, senior analyst
I'm reluctant to call a purchase of Wal-Mart stock an endorsement -- or condemnation -- of the U.S. consumer and retail stocks. You could call it a positive signal, but you could also reference the oft-cited Wal-Mart "trade-down." So unless Soros and Buffett start buying retail stocks en masse, I wouldn't call this anything.
I think the U.S. consumer built up above-average levels of debt and below-average savings in recent years, and I can't see a reason why that's a sustainable phenomenon. So, given the recent run-up, I can hardly call myself bullish on retail stocks.
I do, however, think that stock pickers can still scout out some good opportunities in retail, and I think one of those opportunities is CarMax (NYSE:KMX). The price isn't fabulous at these levels, but its no-haggle model, focus on providing value to customers, and wealth of sales data leave it ideally positioned. And with Cash for Clunkers done with, I think folks are more likely to opt for used cars than new.
Nate Weisshaar, senior analyst
I think the deleveraging of the American consumer is far from over, and I believe that will result in a hole at the midpriced level of the retail spectrum. Most shoppers will be looking for the best deals, while the more fortunate shoppers will continue to pay up for high-quality, premier brands -- albeit less frequently. The winners in this scenario will be the Wal-Marts of the world on one end, and the Luxotticas and Coaches (NYSE:COH) on the other.
The retailers that rely more on the whims of fashion-chasing teenagers will likely be left blowing in the wind -- hot one season, cold the next, with no real clarity on the future. Wall Street hates uncertainty more than anything else, so while well-run operations will make it through, there will be blood. Investors will have to pick carefully if they plan to venture into this industry.
Andy Cross, Hidden Gems co-advisor
Retail stocks always garner a lot of attention from individual investors, because we know the stores and the products. Almost everyone has shopped in a Target (NYSE:TGT) or J.C. Penney at some point during their lifetime. That personal connection goes a long way for investors, because it makes the business far easier to understand than that of, say, a reinsurer or semiconductor manufacturer.
But that doesn't necessarily make retail companies more successful. In reality, long-term successful retailers like Tiffany are the exception, rather than the rule. Yet every investor likes to think he or she has found "the next Wal-Mart" when investing in some hot, fashionable start-up.
That's why, when it comes to retail stocks, I prefer to focus on winners that have dominated and expanded their niche for years. Staples (NASDAQ:SPLS) comes to mind. It basically created the office supplier superstore, and now it's pushing its expertise online and into supply distribution, two niches that didn't exist 15 years ago. It also has a growing international operation, so it's not 100% dependent on U.S. consumers.
That's also why I like Coach. Its successful launch into China has sown seeds that the handbag fashion icon will reap for years -- just as it did with Japan in the 1980s.
Seth Jayson, Hidden Gems co-advisor
I think the "Soros and Buffett love Wal-Mart" story will be misunderstood on many levels. First, this doesn't indicate any particular love of retail. Buffett hasn't always been successful in his forays into retail, and because of its size, Wal-Mart is one of the few retailers that Buffett can even consider investing in. We could even consider this a bet against retail -- that is, Buffett and Soros assuming that Wal-Mart is the beast that will gobble up the rest of its retail rivals.
Retail is tricky, and I have a hard time liking most of the companies in this industry. They're at the mercy of fickle consumers, and unless they're careful, they don't have much of a brand to fall back on. I prefer hybrid companies with strong niches, like Fossil and Guess? -- both of which I own.
These two companies have founder-led cultures, high insider ownership, great cash flow production, and brand names that resonate internationally. They do much of their business in wholesale or partner channels, but they've been growing their own retail presence in select markets, in order to capture more of the margin where possible.
Trouble is, neither has looked particularly cheap for the past six months. But then again, both have outperformed peers and expectations over that time period, and if they do things right in Europe and Asia, it's hard to see the ceiling. That's why they're both Hidden Gems portfolio candidates.
