Quick Thoughts – Retail


Retail earnings this morning are a bit dicey, with notable weakness from a number of different companies – SPLS, HD, TJX, URBN and DKS.

We see these results as consistent with our commentary last week where we laid out (again? still?) our cautious view of the U.S. consumer and, by extension, the consumer discretionary sector;

o   Broadly speaking, valuations remain demanding;

o   Income and employment growth (and, by extension, spending) remain sluggish;

This morning’s news flow does nothing to move us off our position.

In that same note last week, we flagged our concern regarding HD (and LOW) within the context of a continued positive bias based on still solid residential construction spending trends (Exhibit 1).

o   HD did miss consensus EPS ($0.96 versus $0.99) and comp (+2.6% versus +4.8%), at the same time suggesting that May sales were healthy, trumping the weakness in the quarter.

SPLS is an example of hope exceeding reality, and while we do see the value proposition associated with the company’s offering, the level of investment required to stabilize the trends in the North American Retail and International segments remains an open issue (North American Contract business was a bright spot in the results).  Having said that, the stock has been very resilient toward $11 per share, well-supported by a chunky and sustainable yield (4%+ at that level) that makes the name an intriguing long either for more patient deep value accounts or for faster-money accounts that can play for a bounce (admittedly a weird mix of potential buyers).

Within the context of this retail landscape, BBY’s print and stock response concerns us, and despite our prior, trading-oriented bias on the name below $25 per share, we have about zero interest in taking event risk;

Finally, based on results so far, we think that KSS makes sense on the long side at current levels;

o   KSS at $50 is admittedly more a valuation call than some insight into whether or not sales at are at inflection point, but with the company trading at 12.3x the low end of management’s guidance range ($4.05 – $4.45) and a robust FCF yield (10%+) we like the support for investors as they wait and see what unfolds in the balance of the year.  The risk reward makes sense to us at $50, as we see limited ($5 downside) and as much as $10 in upside should sales start moving in the right direction.


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