Consumers Are Back: How to Shop for Retail Stocks

Consumers Are Back: How to Shop for Retail Stocks

REUTERS/Yuriko Nakao

Running a retail empire is getting more difficult by the day. Not only do you have to stay ahead of the trends, but you had better be prepared to offer the most sought-after items at the very lowest prices. Just ask Best Buy (NYSE: BBY) and J.C. Penney (NYSE: JCP) what happens if you can’t manage to pull that off…. Your customers are finding their disposable income is shrinking, thanks to higher payroll taxes and rising gasoline prices. Then a series of winter storms blow across large swathes of the United States, making it harder for those grumpy, cash-strapped and picky customers to even get to the mall in the first place.

In spite of all that, retail sales managed to climb 1.1 percent in February over January, and 4.6 percent over year-earlier levels. Even though the rise in gasoline prices accounted for a chunk of that higher spending, that is still a much better performance than many economists had been anticipating. But it really isn’t going to change very much for the retailers themselves – or for investors in retail stocks. The winners are likely to continue to battle the desire on the part of consumers for value pricing and spending restraint; odds are that the losers will keep on losing ground and risk following the likes of Borders into oblivion.

One standout in the crowd at present is Gap Stores (NYSE: GPS). Its Old Navy division reported a big jump in same-store sales in February – that part of the business is a play on the super price-conscious consumers of the kind that also spend their money at Wal-Mart (NYSE: WMT) and at dollar stores. The middle-of-the range Gap brand has done well by providing low-cost fashion that is squarely on target – colored denim last spring and colored corduroy pants over the winter. It seems to be walking a fine line, keeping prices in a range that doesn’t alienate its customers while still maintaining its margins, staying ahead of the fast-moving style curve, managing inventory to keep just enough on hand so that shoppers don’t go away empty-handed but not so much that it has to slash prices to unload its stock. A notch up is Banana Republic, now launching its next “Mad Men” collection tied to the hit cable television series.

Some economists view the February results with wariness or downright skepticism. Ryan Sweet, a senior economist at Moody’s Analytics, called them “suspiciously strong.” He doubts the pace is sustainable and worries that Washington policymakers – trying to find a path out of sequestration and some kind of medium-term compromise on fiscal policy – will interpret the relatively strong gains in February as meaning consumers will keep spending regardless of the hit to their wallet.

The truth is that some consumers will get accustomed to their new levels of disposable income, if not return to their previous spending levels. We’ll hit some kind of “new normal” as the shock of the smaller paychecks wears off and consumers reset their priorities. It might mean that spending doesn’t grow as rapidly, or that the pattern of the gains shifts in favor of different groups of retailers (as we already see happening with the various divisions of Gap).

But Sweet could well be on target when he suggests that some of the tailwinds that helped February spending levels – tax refunds or the anticipation of tax refunds, year-end bonus payments, special dividend payments by companies made in the final days of 2012 – won’t be there in the coming months. February job creation may have been much stronger than anticipated, but that’s a single data point. To the extent that the Washington stalemate leads to government furloughs or even layoffs, those tailwinds could be replaced with headwinds.

Certainly, many of the retail industry losers are likely to find their prospects becoming gloomier still as the year unfolds. J.C. Penney has lost many loyal, long-term customers without – as it had planned and expected – winning new ones more willing to spend and less focused on bargains in their place. Nonetheless, Ken Hannah, the company’s CFO, told a presentation at a Bank of America Merrill Lynch conference that neither he nor much-criticized CEO Ron Johnson has plans to depart any time soon.

Still, my own stroll through a crowded mall in downtown Providence, R.I. on Saturday showed that one corner of the mall was hushed enough to appear as if it was closed: the entrance to J.C. Penney, beyond which the entire store appeared to be empty. Best Buy is another company teetering on the verge of … something.

Even within groups that are doing well, there are trouble spots. Wal-Mart isn’t keeping pace with Target (NYSE: TGT) or Costco (NASDAQ: COST). Apparel retailers may be generating respectable growth in same-store sales – but don’t tell that to Zumiez, a retailer of clothing for teenagers that saw February same store sales plunge nearly 9 percent, more than four times the expected decline.

Although the housing market remains strong and consumers spent much of last year buying new furniture and appliances for their existing or new homes, Sweet at Moody’s Analytics noted that February data disclosed that sales declined at furniture stores and department stores. That, he says, suggests “there was little wealth-effect spending generated by rising stock or housing values last month.”

It may not be time to panic about the health of either the consumer or the economy as a hole, but it may well be time to become just as picky when it comes to retail stocks as shoppers are in their constant quest for bargains.