Retail stocks have been struggling for some time now, but all is not lost. There are some bright spots in the consumer discretionary sector—those companies that are off-price retailers or specialty retailers with exciting growth profiles. The MoneyLetter  contributing editor John Stephenson picks three standouts in the group to buy now.
Despite renewed international trade concerns, stocks have largely recovered from the recent volatility that sent the S&P 500 and Dow industrials into correction territory. Concerns about an overheating economy and higher interest rates have now eased. Some investors fear that significantly higher inflation will give the Federal Reserve a freer hand to raise rates more quickly than anticipated, pushing up bond yields and making stocks less attractive.
Stocks had come under pressure earlier in March as investors worried that US tariffs on steel and aluminum could hurt firms that use the metals to manufacture goods. And some are concerned that other countries might retaliate, slowing international trade and, eventually, weakening global economic growth.
The perceived instability in US President Donald Trump’s administration has kept stocks back of late, with reports coming out that the US might impose extra tariffs on Chinese imports, and news that US retail sales have fallen for a third consecutive month.
However, recent data have pointed to more measured economic growth that some think should keep the central bank on a gradual path. Some analysts think division among investors over interest-rate increases will continue to swing markets.
Recent data from the US Labor Department revealed that business prices rose 0.2 per cent in February, a sign of modest inflationary pressure. Americans cut spending at retailers in February for the third consecutive month, despite receiving bigger paychecks, the Commerce Department said.
Retail stocks suffering from downbeat sales
In recent trading, retailers’ shares have declined following downbeat retail sales numbers.
Last year was characterized by declines in mall traffic and wallet-share shifts away from apparel. Most investors focused on mall decline, as Amazon continued to grow share, and the potential for further margin declined. There were 2,300 announced apparel store closings last year, and recent data are pointing to fast-fashion saturation in the US, exemplified by H&M’s recent earnings miss and Primark’s roll back of its existing US square footage. Mid-tier department stores continue to close in the US, and over the last 12 months some $15 billion in apparel revenue is now up for grabs, something that could continue to support the off-price retail category.
The fourth quarter of 2017 saw retail stocks rise, as US tax reform became a reality and post-election shock of the prior year made the relative performance of the quarter seem attractive. On average, the group rallied 20 per cent in the last 2 months of 2017.
Since 2010, department stores and specialty soft-line stores (e.g. apparel or bedding) in the US have spent over $18 billion in CapEx (capital expenditure) dollars, with a large focus on online and Omni-Channel (an integrated marketing approach to give shoppers the same experience across a range of physical or electronic retail outlets) investments. Today, many of these Omni-Channel capabilities are in place, which should help reduce margin pressure. Given the US tax reform, I estimate that free cash flow is likely to get a 20 per cent lift, with the view that the group generally won’t be in an investment catch-up mode, as we are in late cycle in the Omni-Channel story.
3 consumer goods retail stocks I recommend
While retail stocks in general are poised to give up their fourth quarter gains from 2017, there are a few standouts in the group that investors should consider.
One name that I like in the retail space is off-price player and margin expander Burlington Stores Inc. (NYSE—BURL). Burlington Stores Inc. is a holding company that operates through its wholly-owned subsidiaries Burlington Coat Factory Warehouse Corp. and Burlington Coat Factory Investments Holdings Inc. It provides an extensive selection of moderate, fashionable, branded products in women’s ready-to-wear apparel, menswear, youth apparel, baby products, footwear, accessories, home goods and coats.
Burlington Stores is headquartered in Burlington, NJ. Burlington’s ongoing initiatives to improve all aspects of the business including merchandising (more emphasis on under-penetrated women’s sportswear, home and bath & body categories), selling (store remodels, employee training and increased minimum wages) and marketing, all suggest that Burlington can continue to improve its sales productivity consistently, and sustain comparables slightly above its peers, largely driven by traffic gains. I have a ‘Buy’ rating and a twelve-month price target of $145 per share for Burlington Stores.
LULU and The Goose
Apparel innovator and rising international story lululemon athletica inc. (NASDAQ—LULU) is another retailer I really like. Founded in 1998, lululemon is a designer and retailer of yoga- and athletic-inspired apparel and accessories. The company targets mostly 30-year-old, educated, higher income men and women via its 406 stores in the US, Canada, Australia, New Zealand, Europe and Asia. In 2016, 73 per cent of its revenues came from stores, 19 per cent from the website, and 8 per cent via other channels (showrooms and select wholesale accounts).
In a specialty retail space desperate for growth, my ‘Buy’ rating on LULU is based on the expectation for sustained high-to-low double-digit top-line, assuming low- to mid-teens square footage growth, including international expansion. I also expect margins to return to the high-teens to 20 plus per cent level by 2020, aided by merchandise margin expansion due to more favorable product costs and select pricing opportunities. I have a ‘Buy’ rating and a twelve-month price target of $100 per share for lululemon athletica.
Early-stage lifestyle-brand momentum story Canada Goose Holdings Inc. (TSX—GOOS; NYSE—GOOS) is another stock in the retail sector that I like. Founded in 1957, Canada Goose is a premium, global outerwear brand. The company’s products are sold via a network of select outdoor, luxury and online retailers and distributors across 36 countries, company-operated e-commerce sites, and two retail stores (Toronto and New York). Despite its 60-year history, I see Canada Goose as still in the early stages of a growth trajectory, particularly in the fragmented and growing premium outerwear market.
I also see Canada Goose’s premium positioning, technical emphasis, strong and authentic heritage, customer loyalty and seasoned management team as key assets as the brand approaches CAD $1billion in sales, from CAD $404 million today. In a global discretionary environment desperate for growth, I see multiple levers for a high-teens revenue growth for the next 3-5 years, including: 1) highly productive square footage growth toward 30-50 stores longer-term; 2) double digit e-commerce increases with the roll-out of additional country-specific sites; 3) 6-8 per cent wholesale gains; 4) geographic expansion; and 5) category expansion. I have a ‘Buy’ rating and a twelve-month price target of $50 per share on Canada Goose.
Retail stocks have been struggling for some time now, but all is not lost. There are some bright spots in the consumer discretionary sector—those companies that are off-price retailers or specialty retailers with exciting growth profiles. Also helping to support a select group of retailers is an improving competitive backdrop, as peer store closures have led to a better supply/demand equation, as well as improving returns on retailers’ Omni-Channel efforts, as Buy Online, Pickup in Store, Ship from Store, Reserve in Store, etc. initiatives are up and running.
John Stephenson is an award-winning portfolio manager and the President and CEO of Stephenson & Company Capital Management Inc. in Toronto. He is the author of “The Little Book of Commodity Investing” and “Shell Shocked: How Canadians Can Invest After the Collapse.” He is also the publisher of Strategic Investor (www.StephensonFiles.com). He can be reached at (647) 775-8360 or (844) 208-8817, or firstname.lastname@example.org.
This is an edited version of an article that was originally published for subscribers in the March 2018/Second Report of The MoneyLetter . You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter. 
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