Separating the Winners and Losers in Retail Stocks

Retailers are by far the most despised stocks in the market right now. The retail industry has repeatedly failed to meet analyst earnings expectations throughout the year, for a variety of reasons.
Right out of the gate in 2015, the problem was that the weather was too cold in first few months of the year, which suppressed consumer spending on spring apparel. Now, management teams across the industry are blaming poor third-quarter results on the weather being too warm, which is holding back spending on cold weather gear for the winter.
Investors are likely confused by all of this, since retailers had the wind at their backs heading into 2015 due to low energy prices. Major retail stocks like Macy’s (NYSE: M) and Kohl’s (NYSE: KSS) reported earnings this week, and once again, the news was mostly bad.
Macy’s failed to meet analyst estimates for the third quarter, while Kohl’s squeaked by with an earnings beat.

A Tale of Two Retailers

Macy’s reported a 3.9% quarterly decline in same-store sales, which measures sales at stores open at least one year. Including sales at licensed departments, sales fell 3.6%, which woefully missed expectations of a 0.2% increase. Total sales fell 5% to $5.8 billion, again missing estimates of $6 billion.
Earnings fell 41% year over year to $0.36 per share. To be sure, much of this was due to store closures. Macy’s previously notified investors it would close around 5% of its stores due to underperformance. Excluding these charges, earnings fell to $0.56 per share.
Macy’s also concluded it will not pursue a real estate investment trust structure, an idea some of its investors were pushing for. The hope was that a REIT spinoff could unlock some of the considerable real estate value Macy’s is carrying on its balance sheet, which is not currently valued highly by the market. Macy’s shares have fallen 38% just since the beginning of the year.
For its part, Kohl’s fared better after reporting third-quarter earnings. The stock rose 7% as the company beat analyst estimates on profit. Overall, earnings per share fell 10% year-over-year to $0.63. Adjusted for a loss on extinguishing debt, the company earned $0.75 per share, which beat the $0.69 per share expected.
Sales rose 1% year-over-year and also topped expectations. Kohl’s attributed its success to a strong back-to-school shopping season, partially offset by a weak September. Kohl’s performed better than Macy’s last quarter, because Macy’s sells more items that are seasonal in nature.
Such poor results are very confusing, because it was widely assumed that retailers would perform well this year. After all, energy prices have collapsed in 2015. Heating oil and gas prices are at multi-year lows, which in theory should put more money in consumers’ pockets. But a common theme from retail management teams is that consumers are spending that extra disposable income on experiences rather than merchandise.
With that in mind, it’s hard to come up with any reason at all to like retail stocks. Fortunately, there are a couple of reasons to consider buying Macy’s or Kohl’s.

After the Sell-Off, Retail Stocks Are Cheap

Neither Macy’s nor Kohl’s, despite its earnings beat, have performed well this year. Both companies are suffering earnings declines, and it is clear that retail as a whole is not doing well this year.
The good news from the retail stocks getting pounded so mercilessly this year is that they are now cheap. Macy’s and Kohl’s both trade for 10 times earnings, which is a significant discount to the broader market levels. The S&P 500 as a whole trades for approximately 19 times earnings.
In addition, their low stock prices have pushed up their dividend yields, which rise as stock prices fall. Macy’s and Kohl’s yield 3.5% and 4%, respectively, which is the highest they have yielded in the past five years.
Macy’s and Kohl’s are universally hated stocks. In order to get investors feeling good again, it will be crucial for both companies to have a strong holiday shopping season in the United States, which is a crucial period for retailers.
As a result, while they have performed very poorly this year, Macy’s and Kohl’s stocks could be attractive buying opportunities for value and income if they can have a good showing in the fourth quarter.

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