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Down but Not Out: These retailers are crying out for a pickup

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To assume that we have bottomed out in the market would be rash. It’s one of the craziest environments the financial markets have seen in decades, and the truth is, no one knows if there’s more room for stocks to fall. Nevertheless, with the S&P 500 (SPX) down about 22% from its highs and the third-quarter earnings season is off to a rather good start, it may be wise for investors to start wondering which stocks have actually bottomed.

In my opinion, one industry, in particular, may include stocks that have become too cheap to pass at current price levels – like TGT and LOW. In particular, the stock prices of giant retailers have already suffered quite dramatically, while some of their earlier headwinds have apparently started to ease.

Why Retailers Could Be an Attractive “Bounce” Game

Assuming that general market sentiment is heading for a reversal, retailers could be bearers of a significant upside as their stock prices have remained depressed despite the recent improvement in the outlook for the industry.

One of the toughest challenges the industry has faced in recent times has been soaring shipping costs amid the supply chain crisis that has persisted following the COVID-19 pandemic. Last month, we discussed the impact of supply chain bottlenecks on e-commerce inventory, but conventional retailers have also been impacted by soaring transportation costs.

Container ship freight rates may still be more than double their 2017-20 levels, but they have corrected nearly 70% from last year’s highs. This should reduce transportation costs for retailers and enable inventory management optimization, which should lead to margin expansion and, therefore, higher profits.

Source: Freightos

Additionally, most major US-based retailers do not have significant international exposure. This is important to note, as the continued strength of the dollar should not cause significant headwinds on exchange rates.

Finally, inflation levels could remain quite high. However, most retailers operate in the defensive consumer sector, which is the only sector that should withstand strong inflationary environments quite firmly.

Consumers will frequently stop at retail stores to purchase their basic necessities – products whose demand is highly inelastic and generally uncorrelated to the underlying state of the economy.

Even home improvement retailers (part of consumer discretionary) are expected to perform well as consumers may prioritize improving their home during a market downturn over buying a property. , especially with rising rates.

In my view, as retailers adjust to these factors and the new reality, including the possibility that above-average levels of inflation will be the new normal for some time, their earnings growth should resume quickly. Wall Street analysts seem to agree with this argument.

Take Target Corporation (NYSE: TGT), for example. While the company is expected to post earnings per share of nearly $8.00 for fiscal 2022, implying a roughly 40% year-over-year decline, earnings are then expected to rebound nearly $8.00. 48% in fiscal year 2023.

Source: Koyfin

This seems to be a constant trend in the industry. Consider Walmart (NYSE: WMT) too. The company’s earnings per share for this year are expected to fall 9.4% to $5.85, but rebound nearly 13% to $6.60 next year.

Source: Koyfin

Which retailers should you turn to?

As I mentioned, we simply cannot know if stocks, including retail stocks, can go down further. Any exogenous shock can easily sway the markets forcefully in both directions these days.

Therefore, I would opt for quality names that are trading at a discount while offering strong dividend prospects. This is to have as wide a safety margin as possible against further declines in the share price.

Thus, while Kohl’s Corporation (NYSE: KSS) and Macy’s (NYSE:M) are trading at single-digit forward P/Es, I wouldn’t touch them as their qualities are questionable and their balance sheets mediocre.

Simultaneously, while Costco Wholesale Corporation (NASDAQ: COST) is arguably one of the most qualitative names among its peers, paying 32 times forward earnings in a rising rate environment is crazy in my book.

Source: Koyfin

Then you have Target and Lowe’s Companies (NYSE: LOW), which trade at reasonable multiples while offering quality dividends. For context, both companies have increased their dividends for 60 and 54 years, respectively. This is great validation in terms of being able to generate strong cash flow and continue to provide investors with growing payouts even in the toughest economic environments.

Of course, Walmart also has 50 years of successive dividend increases, and I consider it a quality company as well. However, by paying 23 times forward earnings, there is a big crack for an investor’s total return prospects to be compromised if the markets decide to move further south.

Conclusion: Go for Cheap and Quality Retailers

All around, I think if we are indeed approaching a market bottom, giant retailers are likely to prove successful investments following the sharp decline in their stock prices.

Supply chain bottlenecks are easing, which should allow for potential margin expansion, while their strong pricing power should be a great advantage in the current high inflation environment.

Still, make sure you’re getting solid value for what you’re paying for and that there’s a strong dividend attached to your stock of choice. This way, even if the market crashes in the short term, you’re still invested in a quality business that you feel comfortable owning for the long term. Benefiting from increasing payments in the meantime is also a great advantage.

Disclosure

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.