A Tour of the Retail Sector for July
8/6/2010
July same-store sales for retailers, for lack of better words, stunk. Mixed bag doesn't quite capture my thoughts as the numbers were crossing the tape. I think a sense of realism was evident in the data, realism that the U.S. consumer continues to be in a much different frame of mind than before the Great Recession. With a savings rate nearing 7% after declining for months, the consumer is sending a message to retailers; discount or we will not open our wallets. As a result, all signs point to the back to school shopping season being highly promotional, which in turn raises the question as to the profitability of the sector during the holiday season. Detailed below are snippets of updates on stocks post July same-store sales releases that I cover for our institutional clients. As will be readily apparent, specialty retail chains are taking it on the chin due to tough competition from each other and by a resurgent department store sector. Discounters are likely to have a respectable back to school season. Note Wall Street Strategies is included in the Thomson Reuters consensus financial estimates. Abercrombie & Fitch Co. (ANF) Somewhere along the way it became cool once again to shop at Abercrombie & Fitch (ANF). Well, that may be a stretch, as we believe the company's aggressive pricing at each division is luring in customers that know Abercrombie is a premium brand on sale. The customer realization that Abercrombie is more affordable than years gone past began in May, in our view, as comps in the namesake division, abercrombie, and Hollister have all turned up since then. Even we must admit that product at the Abercrombie & Fitch division, though having lower quality compared to prior seasons (our sense), is better on the fashion front (especially for girls). For July, Abercrombie reported a +7.0% comp (consensus: +4.0%), benefiting from a -15.0% AUR reduction overall and still favorable year earlier comparisons. International and direct to consumer continue to be growth stories for the Company (though each is off a low base). We have revised up (second consecutive revision) our 2Q10 EPS assumption for Abercrombie after it pre-announced sales $20.0 million ahead of our modeling ($745.0 million versus $720.0 million). The Buy rating, which we issued on August 4, remains intact. Aeropostale Inc. (ARO) Seemingly out of the blue, Aeropostale Inc. (ARO) dropped a napalm bomb on the market. The company, which has become a picture of monthly consistency, badly missed comp estimates for July and lowered 2Q10 EPS guidance. We found it somewhat disturbing that a value destination for teen apparel noted a "change in consumer behavior" as a reason for the sales miss. The price gap has narrowed between Aeropostale, American Eagle (AEO), and Abercrombie & Fitch (ANF) and July may represent the start of the consumer trading up for quality even it means a modestly higher ticket price (Abercrombie has lowered prices at all its divisions). Nonetheless, we are reluctant to toss in the towel on Aeropostale as inventory is well controlled and the stock trades at a stark discount to the sector average at 8.7x our downwardly revised FY10 EPS estimate. Fred's Inc. (FRED) We are reiterating our Buy recommendation on Fred's Inc. (FRED), but editing the price target by $3.00 to $15.00 from $18.00 to adjust for slight EPS revisions to our 2Q10 and FY10 modeling. The company recorded July comps of +2.7% on higher customer traffic and strength in the general merchandise category, 0.7% shy of consensus forecasts. Same-store sales have disappointed the market twice in a row, underscoring the pressure on the core Fred's low-income consumer and heightened analyst expectations. 2Q10 revenue growth and same-store sales were below the top-end of management's guidance, but the fact there was no EPS warning suggests favorable business mix may have saved the top line shortfall. Target Corp. (TGT) Beneath the headline July comp for Target Corp. (TGT), which missed consensus for the second consecutive month, there is a positive story. That story is Target experiencing strong sales of food (P Fresh helping), up double-digit percentage for July, with that customer traffic finding its way into higher margin departments such health and beauty and apparel. We are growing concerned about Target's sales trends in the West, as Arizona was added to the call out as a state of weakness (California consistently soft for over three months). Nevertheless, Target's favorable product mix, in addition to tight inventory control and a "strong" credit card business, implies that 2Q10 earnings are likely to take the market by surprise. American Eagle Outfitters Inc. (AEO) We are issuing our second consecutive downgrade on American Eagle Outfitters (AEO) shares, this time to Sell from Hold, as the teen apparel retailer is undeniably struggling ahead of peak back to school demand. Promotions are increasing as a result of an excessive inventory position, a bet gone wrong, which is weighing on gross margins. The company's July performance did not suggest recent dour trends stand to reverse in 2H10, with a flat comp on a very easy year ago comparison of -11.0%. We have lowered our 3Q10, 4Q10, and FY10 EPS estimates as American Eagle maintains its promotional cadence given a mixed reaction to newness and tough competition. Costco Wholesale Corp. (COST) We are reiterating our Hold rating and $60.00 price target on Costco Wholesale (COST). Although Costco logged a solid July, with strength in the softlines category counteracted by modest comp gains in hardlines and fresh food, the report did not scream knockout. Gasoline price inflation has become a negative aspect to gross margin as has competitive pricing throughout the sector. For July, Costco has a +6.0% headline comp, or +4.0% ex. currency and gas. Gap Inc. (GPS) We are reiterating our Sell recommendation and $15.00 price target on Gap Inc. (GPS), adjusting our EPS estimates down slightly for FY10 and FY11. Unquestionably, pricing pressure has intensified throughout the specialty apparel sector ahead of peak back to school. In our view, Gap's merchandise margin trend has cooled, and will do so further in 2H10 in light of tough year ago comparisons, increased sourcing costs, and industry -related pressure. July in many respects was confirmation of these items as Gap focused on the top line to move inventory in front of back to school. The reported comp was +1.0%, but traffic was weak outside of Old Navy. Hot Topic Inc. (HOTT) Hot Topic Inc. (HOTT) by far had the most dismal July comp data relative to its peer group. Left without any major, new licenses Hot Topic's core assortment was hung out to dry. The fashion, in our view, is off the mark and product pricing pressure is obvious. Moreover, the interesting product from the company appears to be online only; there is a disconnect between brick and mortar and online. We believe back to school for Hot Topic will be very trying, and that downside risks to consensus earnings estimates exists as promotions are ramped up.
Brian Sozzi
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