1/7/2010
By Brian Sozzi, Research Analyst

More Articles by Brian Sozzi

Those yearning to see the Grinch in the December same-store sales numbers might have to wait for another point in the year.  Based on our research, 80% of the companies reporting December comps this morning beat consensus estimates.  Within this figure, the beats were rather meaningful, and telling at the same time as sell-side estimates have advanced in recent months as consumer centric economic data has improved.  The real interesting food for thought could be found on the earnings line, where 50% of the companies that announced comps this morning issued EPS guidance revisions to the upside.  Considering the holidays were competitive on price and analyst estimates heightened, to see the magnitude of the guidance revisions was striking.  Management teams are operating at a high level, driving supply chain savings and keeping inventories lean.  But, for the first time in a while, greater than expected sales trends appear to be a factor in stronger than previously thought 4Q09 earnings.

Important Observations for the Month

* Online sales for those companies that shared such data rose an average 16%.
* No inventory glut leading into spring.  Post Christmas clearance events and controlled inventories prior to the holidays has established a nice canvass to manage margin in the spring season.
* Sales trends in December were not only fueled by low margin toys and seasonal food; we saw strength in home furnishings, jewelry, and even apparel.  High-end department stores, namely Saks (SKS) and Nordstrom, had strong December comps, suggesting the rise in equity values and debt pay down has opened the consumer's mind regarding discretionary purchases.
* Total sales for the combined holiday period (November/December) were ahead of sell-side estimates for the overall fourth quarter, in some cases materially.  This obviously has positive margin implications as retailers, on balance, held promotions tight and had lean inventory levels.  
* Sales for the week after Christmas, consistent to our observations, were solid.  Consumers returned to the malls not only with gift cards, but with a few extra dollars (cash) in hands to pick up promoted and non-promoted items (such as early spring preview merchandise).  This sets the stage for clean inventory positions for most retailers entering important selling days in 1Q, such as Valentine's Day and Presidents Day (particularly critical since comparisons to positive markup and reduced markdowns amid low inventory begin to get cycled in 1Q09)

Rather than make a broad sector call, we continue to believe it's a stock pickers market within the retail sector this year.  Our concentration for investment purposes are on those companies that sport the following fundamental characteristics:

* High probability for 2H10 sales strength to overcome a likely rising cost backdrop (transportation, supply chain, investments in technology).
* Companies that have transformed how they conduct business (for example: Target is reducing SKU count, Costco has reengineered package sizes and shipment sizes, and American Eagle Outfitters will have dramatically lower lead times for spring merchandise).
* Opportunities to expand operating margins closer to prior cycle peak on a much lower base of "new normal" sales.
* Market share gainers as the retail sector continues to shrink through store closures.
* Attractive price to sales multiples relative to historic averages and sector averages (fits in with our attention on sales this year; a grower of the sales base should create multiple expansion on a P/S basis)

Primary Overweight Recommendations

* Target (TGT)
* Costco (COST)
* Dick's Sporting Goods (DKS)
* American Eagle Outfitters (AEO)
* Guess (GES)

Brian Sozzi
Wall Street Strategies