Retail Industry Stock Outlook - March 2016

Retail Stock Outlook: Can a Good Start Lead to a Great Year?

Retailing involves buying large quantities of goods and selling them in smaller quantities to consumers for a profit. The health of the retail industry is an important economic indicator as it is linked directly to consumers and their propensity to spend. Consumer spending is the key to the well-being of any economy as it accounts for more than two-thirds of the economic activity.

The link between consumer spending and the retail industry becomes more relevant as retail sales attract approximately 30% of total consumer spending in the U.S. Also, the retail industry ranks among the top U.S. industries and employs an enormous workforce, contributing to the health of the job market.

Before jumping on to the trends in retail, here's a peek into the key economic indicators, which suggests where the market is heading.

A recent data revealed that U.S. consumer spending rose at the fastest pace in eight months, climbing 0.5% in January after a 0.1% gain in Dec 2015. This indicates that the U.S. economy was off to great start in 2016 with steady employment opportunities, cheap gasoline, and rising home values that helped to boost the spending appetite of Americans. The report further suggested that income rose 0.5% in January, up from a 0.3% increase in December and above expectations mainly on the back of a 0.6% jump in wages and salaries.

Concurrently, a report by the Commerce Department suggests that the second estimate of real gross domestic product GDP expanded at an annual rate of 1% for the fourth quarter of 2015, above the advance estimate of 0.7%. These reports collectively advocate that the U.S. economy is definitely showing resilience, while keep rumors of an upcoming recession at bay.

Seconding these views, we note that the U.S labor market looks quite stable, with unemployment rate for February standing unchanged from last month at 4.9%. The report by the Bureau of Labor Statistics indicated that a total of 242,000 nonfarm payroll was added in February, of which retail employment increased 51,100.

Given a rebounding U.S. economy, the retail space is bubbling with optimism. This is evident from February's 0.6% rise in retail sales, excluding automobiles, gasoline stations and restaurants, from December 2015 and a 1.4% increase over Jan 2015, as reported by the nation's largest retail trade group – National Retail Federation NRF.

The federation pointed out that the growth in January came despite the uncertain global economic outlook and challenges in the industrial and financial sectors. Sales for the month benefited from a solid labor market, lower energy prices and increased savings that determine consumers' spending power.

Additionally, NRF projects retail sales in 2016 to rise 3.1%, which is higher than the 10-year average sales growth of 2.7%. Online sales in 2016 are expected to increase in the band of 6–9%.

Market experts expect retail sales growth in 2016 to come on the back of improving wages, new job creations as well as steady consumer confidence, which will negate the headwinds from an uncertain global environment, particularly the economic slowdown and financial mayhem in China, the strong U.S. dollar and persistent problems in the energy sector.

Key Metrics

The key data in the retail industry analysis is comparable-store sales (comps) as it excludes sales at newly opened and closed stores. We observe that the sales data for the month of February was mixed. The general challenges faced by retailers in February included an unseasonably warm weather that kept weakened demand for winter wear and gears. Also, the surging U.S. dollar discouraged foreign tourists from spending more. This ultimately hurt the business of U.S. retailers as they were forced to slash prices and elevate promotions to attract traffic.

The list of gainers in February was led by the clothing retail chain L Brands Inc. LB that posted a comps gain of 5% and sales improvement of 5% to $849.3 million. This was followed by apparel and accessories retailer Cato Corporation CATO that reported a 4% increase in comps and net sales gain of 5% to $84.7 million.  

Specialty retailer of durable consumer goods and related services Conn's Inc. (CONNTM) got the third spot, registering a 2.7% increase in comps, while its total sales improved 13.9% to $108.8 million. Discount store operator Fred's Inc. FRED followed with a comps increase of 0.8%, better that the flat comps reported last year. Fred's net sales for Feb 2016 jumped 12% to $171.1 million.

Going down the line, warehouse retailer Costco Wholesale Corp. COST posted flat comps in February, while total sales inched up 1% to $8.28 billion.

On the other hand, the list of disappointers for the month was topped by The Buckle Inc. BKE which witnessed an 8.9% decline in comps and a 7.7% fall in net sales to $81.8 million for February. It was followed by Washington-based retailer of sports-related teen apparel Zumiez Inc. ZUMZ which reported an 8.6% decline in comps, with sales falling 3.9% to $51.9 million from the year-ago period.

Further, teen retailer The Gap Inc. GPS reported a 2% fall in comps and sales decline of 3.3% to $888 million. At the bottom of the list was drugstore retailer Rite Aid Corp. RAD which recorded a 0.8% decline in comps, while total sales inched up 0.1% to $2.562 billion.

Zacks Industry Rank

Within the Zacks Industry classification, Retail/Wholesale (one of 16 Zacks sectors) is divided into two categories -- Nonfood Retail-Wholesale and Food/Drug- Retail/Wholesale under the Medium M Industry Group and further sub-divided into 14 industries at the expanded X level -- Building Products-Retail/Wholesale, Internet Commerce, Retail/Wholesale Auto/Truck, Retail-Apparel/Shoe, Retail-Consumer Electronic, Retail-Discount, Retail-Drug Store, Retail-Jewelry, Retail-Miscellaneous/Diversified, Retail-Restaurants, Retail-RGN Department, Retail-Supermarket, Retail/Wholesale-Auto Parts and Retail/Wholesale CMP.

We divide the 16 Zacks sectors into 60 M-level industries and 250 X-level industry groups. We rank all the 250 plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. To learn more visit: About Zacks Industry Rank. http://www.zacks.com/zrank/about-zacks-industry-rank.php

As a point of reference, the outlook for industries with a Zacks Industry Rank #88 and lower is 'Positive,' between #89 and #176 is 'Neutral' and #177 and higher is 'Negative.'

The Zacks Industry Rank is #4 for Retail/Wholesale CMP, #31 for Retail-Miscellaneous/Diversified, #51 for Retail-Restaurants, #60 for Retail/Wholesale-Auto Parts, #90 for Retail-Apparel/Shoe, #102 for Retail-Jewelry, #151 for Building Products-Retail/Wholesale, #158 for Retail-Supermarket, #163 for Internet Commerce, #163 for Retail-Drug Store, #163 for Retail-Consumer Electronic, #187 for Retail-Discount, #206 for Retail-RGN Department and #229 for Retail/Wholesale Auto/Truck.

On analyzing the Zacks Industry Rank for the constituent industries in this space, it is apparent that the overall outlook for the Retail/Wholesale sector is Neutral.

Sector Level Earnings Trends

The Q4 earnings season is now effectively behind us with results from 496 S&P 500 already on the books, primarily from four of the 16 Zacks sectors (Autos, Conglomerates, Aerospace and Transporters). Coming to the retail sector, the earnings season is still on, with more than one report still to come.

From the recent retail reports, we can conclude that results from this sector were no better than the others. Initial assumptions that improved household buying power, as a result of energy savings, would show up in retail sector results did not translate into reality due to the shift in spending trends to online shopping, along with the competitive retail environment and seasonal factors.

Total Q4 earnings for the Retail sector in the S&P 500 are up only +0.2% from the same period last year, on +5.3% higher revenues, with 54.1% beating EPS estimates and only 35.1% coming ahead of top-line expectations. This performance is weaker than what we saw from the same group of retailers in other recent quarters.

For more details on earnings of this sector and others, please read our ‘Earnings Trends' report.

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