Finding winners in the retail sector can be challenging. Target (NYSE: TGT) demonstrated this recently. The stock plunged more than 12% after the company reported sales and earnings that missed Wall Street’s expectations. Missing earnings is usually bearish but it’s especially bad for a retailer to miss fourth quarter earnings since that is traditionally the strongest quarter for companies in the sector. Target compounded traders’ concerns by lowering its outlook for this year.
Target’s CEO explained the problem, noting “Our fourth-quarter results reflect the impact of rapidly changing consumer behavior, which drove very strong digital growth but unexpected softness in our stores.” This statement demonstrates Warren Buffett’s opinions on the sector.
Buffett, the billionaire investor who runs Berkshire Hathaway, has noted that retail is an especially difficult sector for him. He looks at management before he invests in a business and likes to see managers that are smart with a record of making good business decisions. In retail, Buffett has observed, it’s not enough to be smart. Managers have to be smart every day because the industry and consumer tastes are constantly evolving.
The 86-year old recently explained, “Retailing is tough for me to figure out. If you go back to when I was a kid, in every town, the guy that owned the big department store in town was king, whether it was Marshall Field or Dayton, or Hudson in Detroit. The department store was king. People said, ‘What can happen to it? It’s down there where the street car lines crossed.’ And women took the street car to shop there and they could see 500 spools of thread and 500 wedding dresses and they couldn’t see anything like that. It offered this incredible array of goods.
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“And then somebody came along with the shopping center, instead of making it vertical with all this display owned by one person, they spread it out, owned by many. And now comes the Internet and that’s the ultimate variety of things that you can get to very easily. So, people love variety, they love low prices. It just keeps evolving and the great department stores, many of them have disappeared and the rest are under pressure.”
Target may be the latest casualty in the refill sector but it certainly won’t be the last. However, because the sector is so challenging, there are rewards for investors who get it right. We studied Target’s recent report and drew an important lesson for investors – retailers need to increase sales in order to succeed. Sears, JC Penney and a number of other great and once dominant retailers saw they share price decline as sales declined.
This may sound obvious but that insight allows us to create a screen for potential investments in the sector.
To find potential bargains, we screened for retailers trading at less than $10 a share and showing signs of growth. We required the retailers to demonstrate growth in sales over the long term and we wanted to see this trend continuing in the short term. Finally, we limited our buy candidates to stocks analysts believe will deliver positive earnings per share (EPS) in the next year.
Ascena Retail Group, Inc. (Nasdaq: ASNA) – operates as a specialty retailer of apparel, shoes, and accessories for women and tween girls in the United States, Canada, and Puerto Rico. ASNA has approximately 4,900 stores. The company operates through six segments: ANN, Justice, Lane Bryant, maurices, dressbarn, and Catherines.
Analysts expect ASNA to report earnings per share (EPS) of $0.39 in the fiscal year ending this July and $0.47 next fiscal year. EPS growth is expected to average 21% a year. The PEG ratio can be used to develop a price target for a growth stock. This model assumes a stock is fairly valued when the price-to-earnings (P/E) ratio is equal to the EPS growth rate. For ASNA, a P/E ratio of 21 provides a price target of $9.87 based on next year’s expected earnings. This indicates the stock could potentially double from its current level.
U.S. Auto Parts Network, Inc. (Nasdaq: PRTS)- operates as an online retailer of aftermarket auto parts and accessories primarily in the United States, Canada, and the Philippines. The company operates through two segments, Base USAP and AutoMD. PRTS also sells and delivers auto parts to collision repair shops from its Chesapeake, Virginia warehouse facility; markets Kool-Vue products to auto parts wholesale distributors; and serves consumers by operating a retail outlet store in LaSalle, Illinois. Its flagship Websites includes autopartswarehouse.com, carparts.com, jcwhitney.com, and AutoMD.com. U.S. Auto Parts Network, Inc.
PRTS is expected to report EPS of $0.10 in 2017 and $0.15 next year. The PEG ratio provides a price target of $7.50 making PRTS could also nearly double in price.
ZAGG Inc (Nasdaq: ZAGG)- designs, manufactures, and distributes product solutions for mobile devices. It offers solutions, such as glass and film screen protection products, keyboards for tablet computers and mobile devices, keyboard cases, earbuds, cables, and cases under the ZAGG and InvisibleShield brands, as well as portable batteries to charge various devices that utilizes a USB, including smartphones, tablets, handheld gaming systems, and digital cameras. ZAGG sells its products through big box retailers, domestic and international distributors, independent Apple retailers, university bookstores, and small independently owned consumer electronics stores, as well as on its Website at ZAGG.com.
ZAGG is expected to turn profitable this year with EPS of $0.58, following a loss of $0.17 in 2016. The introduction of a new iPhone could lead to positive earnings surprises and additional interest in the maker of cell phone accessories. This could lead to the stock exceeding its price target which already shows strong potential gains are possible in the stock. A conservative target, assuming a P/E ratio of 21, the long term industry average, is $12. This is about 90% above the current stock price.
The Container Store Group, Inc. (NYSE: TCS)- is focused on the retailing of storage and organization products throughout the United States. TCS operates through two segments, The Container Store and Elfa. Its retail stores provide various lifestyle products, including bath, box, closets, collections, containers, food storage, gift packaging, hooks, kitchen, laundry, office, shelving, storage, trash, and travel, as well as elfa branded products.
TCS is expected to report EPS of $0.24 in the fiscal year that ends next March. With an expected EPS growth rate of 51%, the PEG ratio provides a price target of about $12, making TCS yet another undervalued retailer with the potential to double.
Destination XL Group, Inc. (Nasdaq: DXLG)- operates as a specialty retailer of big and tall men’s apparel in the United States and England. Its stores offer sportswear and dresswear, as well as lifestyle products such as, outdoor accessories, travel accessories, bed and bath products, and fitness equipment. The company operates its stores under the Destination XL, Casual Male XL, Casual Male XL Outlets, DXL Outlets, Rochester Clothing, ShoesXL, and LivingXL names.
DXLG is expected to report a profit this year with EPS of $0.08 reversing a loss of $0.04 a share in the fiscal year ending in January 2017. The next year, EPS are expected to increase to $0.18. Using a P/E ratio of 21 to find a conservative price target of $3.80 shows DXLG is potentially undervalued by 40%.