Retail Sector Roundup
9/4/2009
By Brian Sozzi, Research Analyst
Detailed below is an overview of our institutional work on the retail sector following the September 3 same-store sales releases. There has been a litany of positive analyst notes out in response to same-store sales that, on balance, outpaced consensus estimates. Moreover, the month to month improvement in customer traffic is being talked up as a sign the consumer is back and is poised to open up the spending spigot this holiday season. Not so fast is the best way to characterize my views. Customer traffic in August did in fact gain momentum for some in the retail sector, such as Gap, Costco, and Target. All of these companies had two things in common, great product and great prices. But, digging beneath the traffic data it's evident that consumers are still bypassing discretionary items that are critical to driving a retailer's margin. For example, Costco was still running negative comps in non-food categories despite the 5.0% increase in customer traffic. Target, on the other hand, had flat traffic month to month but still notched mid to high single digit percentage comp declines in its home and apparel departments.
Already, I am seeing analyst notes err on the side of caution with purchasing retailer shares going into the holiday season; this affirms my views offered months ago. Consensus EPS estimates for 2H09 have gotten completely out of whack; heck on more than one occasion I have had to step back from the spreadsheet and reevaluate my modeling based on my core thesis (savings rate creeping to over 10.0%; need-based buying continuing; balance sheet de-leveraging not being a made up phenomenon). The ratings below are long-term oriented, based on valuation or views on where certain companies could be in 2010 from an operations standpoint.
American Eagle Outfitters Inc. * Ticker Symbol: AEO * Rating: Sell * Price Target: $11.00 * Rating Action: Reiteration
Overview The market cheered American Eagle Outfitters' better than expected August comp, but is it a true sign that things are on the mend? August comps were -7.0% (consensus: -8.3%), comprised of mid-single digit percentage comp declines in women's and high-single digit percentage comp declines in men's. It was noted that men's and women's woven tops performed best, complimenting success in new denim styles and fits for back to school. Considering that the American Eagle women's business has been entirely weak for an extended period of time, the commentary on early back to school trends was encouraging. Nevertheless, we continue to view American Eagle in a precarious position, having to compete on price with Aeropostale and with stronger quality at improved pricing at Abercrombie & Fitch.
Abercrombie & Fitch Co. * Ticker Symbol: ANF * Rating: Buy * Price Target: $38.00 * Rating Action: Reiteration
Overview Abercrombie & Fitch Co. stunk up the joint for yet another month as teens shunned the offerings at all brands in the portfolio. August comps were -29.0% (consensus: -23.9%), in what was the Company's' toughest comp comparison of 3Q09. Women's at all brands continued to suffer more so than men's; we attribute the dichotomy to only modest awareness of increased fashion in the assortment and continued migration of purchases to Aeropostale, H&M, and Forever 21 where prices are simply lower. Comps by brand were particularly disappointing when seeing increased transaction value declines month to month. AUR was -8.0% in August. Nevertheless, we view the stock as a Buy due to indications of expense discipline and earnings tailwind in FY10 from the closing of Ruehl operations.
Aeropostale Inc. * Ticker Symbol: ARO * Rating: Buy * Price Target: $47.00 * Rating: Reiteration
Overview Coming as no surprise, Aeropostale Inc. notched the best monthly comp from its peer set in August. Comps for the month were +9.0% (consensus: +6.9%); outside of Buckle Inc. (+3.4%) and Old Navy (+4.0%), Aeropostale was the lone positive comp from specialty apparel. Flat AUR is a positive given the extent of discounting we saw throughout the month in the malls; mid-single digit percentage gains in UPT and overall transactions suggest continued strong interest in the Aeropostale brand. We continue to believe Aeropostale will be the de-facto destination for teens in 2H09 given strong value and fashion in the assortment and very effective promotions. The company's ability to plan its business is leading to minimization of downside EPS risk.
BJ's Wholesale Club Inc. * Ticker Symbol: BJ * Rating: Sell * Price Target: $27.00 * Rating Action: Reiteration
Overview The streak of negative comps for BJ's Wholesale Club Inc. now totals six as it contends with tepid demand for discretionary merchandise and deflation in consumables. August comps for BJ's were -6.0% (consensus: -8.0%), missing the -3.5% to -5.5% guidance range issued on the 2Q09 earnings conference call. It was stated that the shift of the Labor Day holiday negatively impacted August comps by 2.0%. But, still, trends within perishables signify deflationary forces are becoming a real headwind for BJ's while non-food sales have not picked up momentum. Moreover, Costco Wholesale's -2.9% comp represented the second consecutive month of outperformance relative to BJ's, possibly indicating a market share shift.
Costco Wholesale Club Inc. * Ticker Symbol: COST * Rating: Hold * Price Target: $55.00 * Rating Action: Upgrade from sell
Overview Costco Wholesale Corp. was a surprise among the litany of August same-store sales reports. After posting largely disappointing comps since last summer, August 2009 may go down as the inflection point in Costco's business. The company posted an August comp of -2.0% (consensus: -5.9%) against a tough +9.0% year ago comparison. Traffic was a robust +5.0%, surpassing that of BJ's Wholesale Club (+4.0%) and Target (flat) during the month. While food sales continued to outpace non-food and deflation crept increasingly into the picture, more discretionary departments did in fact experience a modest sales up-tick m/m. This followed improved reads in non-food categories in recent months.
That said, the valuation of Costco's shares leaves the company minimal margin for error, but in our view continued improvement in comps is now probable looking out to a six-month time horizon.
Gap Inc. * Ticker Symbol: GPS * Rating: Buy * Price Target: $25.00 * Rating Action: Reiteration
Overview Go figure, Gap Inc. is standing out as one of the positive stories from the retail sector in 2009. The turnaround story strengthened only in August as the Gap brand's 1969 premium denim campaign and Old Navy's better merchandise drove a -3.0% comp (consensus: -7.0%). During our NYC tours, we observed strong traffic at Gap stores, with strong activity in the women's department, especially around the denim and woven tables. Old Navy had an August comp of +4.0%, representing the only positive read within specialty apparel during the month. Brand appropriate merchandise and effective marketing were the catalysts. Even Banana Republic's -8.0% comp improved y/y. As Gap increases its marketing investment to drive pre-holidays sales, we believe consumers will be pleasantly surprised by the merchandize the stores will be offering.
Hot Topic Inc. * Ticker Symbol: HOTT * Rating: Sell * Price Target: $6.00 * Rating Action: Downgrade from hold
Overview August was very disappointing for Hot Topic Inc. on the comp line. Comps (-8.1%) fell outside of both the guidance (-mid-single digit percentage) provided on the 2Q09 earnings conference call just a few weeks ago and most estimates comprising the monthly consensus. The main focus point is on women's, where comps declined a steep 29.0%. In our view, the disappointing comp in this area of the assortment reflects teens migration to specialty apparel stores that offer more basic denim (washes and fits) rather than the embellished, rock infused styles being seen at Hot Topic. Moreover, we believe that the disappointing comp is indicative of soft sales in week four of August as parents held back spending in anticipation of deeper sales during the Labor Day holiday weekend.
Ultimately, we would be surprised if Hot Topic meets its EPS guidance for 2Q09. Comp inventory is expected to be only flat to down slightly year over year to end 3Q09, against a comp decline of about 6-9%. This translates into gross margin pressure and concerns of whether New Moon merchandise (Twilight series) can be the saving grace for the holidays.
Target Corp. * Ticker Symbol: TGT * Rating: Buy * Price Target: $56.00 * Rating Action: Reiteration
Overview Target Corp. (TGT) chimed in with a -2.9% August comp (consensus: -5.2%), fueled by a flat reading for customer traffic. The guest traffic print was particularly encouraging on an absolute basis as Target has worked diligently to improve its value perception with consumers. Perception of brand value picked up in 2Q09, due in our view to the new price matching program. This upward trajectory is critical to Target posting comp increases in 2H09 and into 2010, assuming average ticket bounces back. Although sales by department in August remained skewed to consumables, there were signs of life in apparel and jewelry, two departments that are critical to Target's gross margin.
Brian Sozzi
Wall Street Strategies
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