VDC Vanguard Consumer Staples ETF

The U.S. retail sector is one of the key components of the S&P 500 index accounting for the fifth largest market capitalization level with 9.2% share. Also, the performance of retailers is a key gauge of the consumer spending pattern. This draws attraction toward the sector for a better understanding of consumers’ financial health as well as the stock market’s prospective run.

Q3 Earnings So Far

The sector now seems to have lost some of its shine seen in the second quarter. So far, as much as 86.4% of the Retail sector’s total market capitalization is out with results. Total earnings from the sector are up 8.1% on 3.6% lower revenues. Of the pack, 57.9% of the companies surpassed earnings expectations and 31.6% beat top-line estimates.
 
The blended beat ratio for the sector, screening the ratio of companies surpassing both earnings as well as revenue expectations was also low at 18.4%. The rate was far below 26.3% in Q2 and below the 4-quarter average of 32.9%.

The mixed response in the sector so far can be validated by some of the latest earnings reports discussed below.
 
Results in Focus

Wal-Mart (WMT), a bellwether in retailing, continues to exhibit a sluggish trend even in the third quarter. While the retail giant managed to beat the earnings per share estimate by a penny or 0.88%, it hobbled on the sales front.

A gloomy consumer spending environment globally and currency fluctuations was held responsible for this weak showing.  To reflect the latest underperformance, Walmart also guided down for the full year (read: The Comprehensive Guide to Retail ETFs).

Another retailer, Target Corp. (TGT) – the operator of general merchandise and food discount stores in the United States – also fell shy of the Zacks Consensus Estimate both on the top and the bottom line and trimmed its guidance.  Competitive threats and lack of geographic diversity were deemed responsible for this lackluster performance.
 
Yet another retail firm, Gap Inc. (GPS), lagged the Zacks Consensus sales estimate mainly due to sluggish comps but beat earnings by a penny. Gross margin contracted 120 basis points. On a slightly positive note, the company reaffirmed its guidance.  
 
Kohl’s Corporation’s (KSS) missed both earnings and revenues estimates and lowered its earnings guidance for the full year. Comps declined 1.6% during the quarter compared to a 1.1% increase in the prior-year period.
 
Gross margin shrank 60 basis points. Dollar Tree Inc.’s (DLTR) third–quarter earnings and sales also failed to match the respective Zacks Consensus Estimate.

J. C. Penney Company Inc.’s (JCP) loss of $1.81 per share fared better than the Zacks Consensus Estimate of loss of $1.86. However, sales of $2.8 billion fell short of the estimate while adjusted operating loss significantly widened in Q3.

J. C. Penney now anticipates gross margin and comparable-store sales to improve year over year as well as sequentially in the fourth quarter.

Consumer electronic retailer Best Buy Company, Inc. (BBY) also delivered a mixed bag performance by beating the bottom line but missing the top line. Meanwhile, Macy’s (M) – one of largest department stores – bucked this trend beating the Zacks Consensus Estimate on both lines.

Macy’s surpassed our estimate on both top and bottom lines also remained upbeat on its holiday season business. Macy’s also provided full-year earnings guidance which is well-above our estimated range (read: Retail ETFs in Focus Following Macy's Q3 Strength).

What’s in Store?

Let’s see how things are shaping up for this holiday season. Consumers are buckled with concerns related to the likelihood of another round of government shutdowns, potential Fed taper in early 2014 – if not this month-- sloth movement in the labor market and the recent cut in global growth outlook by OECD all of which definitely have an adverse effect on their spending pattern.
 
For this reason, although the projection for U.S. growth is largely unchanged from the prior forecast of OECD, we expect retailers’ earnings to nudge up 0.7% in Q4 while revenues to grow 2.6%.
 
A tough year-over-year comparison thanks to a shorter holiday season and less number of weekends in the key time frame this year will likely weigh on retailers’ earnings. A leading provider of shopper analytics – ShopperTrak – predicts holiday retail traffic to be 10% lower than the previous year.
 
Prevalence of extreme promotion offers despite lower gas prices also affirms a muted consumer sentiment. Consumer confidence in the U.S. fell in November to 70.4 after a sharp decline in October. The expectation index dropped to 69.3 in November from 72.2 recorded in October.
 
Prior to this, indices logged a sharp sequential decline in October. As of November 7, 2013, the consumer confidence index was hovering around the year-low level (read: 3 Consumer ETFs in Focus on Sluggish Sentiment).
 
However, the story is not entirely gloomy. Many retailers catering to high-end customers held up pretty well ahead of the holiday season. While things are a bit rocky for low-end customers since the broader economy is still on its way to recovery.
 
Market Impact

The earnings picture can be showcased best by ETFs like PowerShares Dynamic Retail ETF (PMR), Market Vectors Retail ETF (RTH) and Vanguard Consumer Staples ETF (VDC) almost all of which have a sizeable allocation in Wal-Mart. Still the funds seem to be less perturbed by the relatively unenthusiastic retail earnings.

Thus, despite an unsteady scenario, identifying some future winners from the sector would be a prudent idea for investors. We believe the sector might come out from the bottleneck next year, suggesting any of these funds might be worth a closer look.

PowerShares Retail Fund (PMR)

This fund provides exposure to the companies engaged in general merchandise stores such as department stores, discount stores, warehouse clubs and superstores by tracking the Dynamic Retail Intellidex Index. The ETF has managed assets worth $40.3 million and charges 63 bps in fees and expenses.

In total, the product holds 30 securities, which is somewhat concentrated on its top 10 holdings with around half of the exposure. In-focus Best Buy and Wal-Mart, each accounting for 4.85%, get places in the top 10.

PMR is a nice blend of Consumer staples and discretionary which makes it open to some capital appreciation and a cushion against volatility. 

PMR gained just 1% in November after accumulating all these earnings results but is up 36.3% so far this year. The product has a Zacks ETF Rank of 1 or ‘Strong Buy’ rating with a ‘Medium’ risk outlook (see all the top Ranked ETFs here).

Market Vectors Retail ETF (RTH)

This ETF tracks the Market Vectors US Listed Retail 25 Index, giving investors exposure to the broad consumer discretionary space. The fund holds about 26 stocks in its basket with AUM of $40.6 million while charging a slightly higher fee of 35 bps per year from investors.

The product has concentration risks in terms of individual holdings with top 10 holdings accounting for more than 59% share. In-focus Wal-Mart and Target Corp have respectively 8.30% and 4.62% of allocation in the fund.  

The fund gained 3% in November and was up 37% for the YTD time frame. The product has a Zacks ETF Rank of 2 or ‘Buy’ with a ‘Low’ risk outlook.

Vanguard Consumer Staples ETF (VDC)

Managing an asset base of over $1.7 billion, this fund provides exposure to a basket of 111 consumer stocks by tracking the MSCI US Investable Market Consumer Staples 25/50 Index. The product charges a low fee of 14 bps per year from investors (see all the Consumer Discretionary ETFs here).

The ETF is highly concentrated across its top 10 companies at nearly 61% of the assets.  Wal-Mart takes up the fourth spot with around 7.0% exposure in the fund.

VDC gained just under 1.5% in November and delivered 23.1% so far in 2013. The fund has a Zacks ETF Rank of 3 or ‘Hold’ rating with a ‘Low’ risk outlook.

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PWRSH-DYN RETL (PMR): ETF Research Reports
 
MKT VEC-RETAIL (RTH): ETF Research Reports
 
TARGET CORP (TGT): Free Stock Analysis Report
 
VIPERS-CONS STA (VDC): ETF Research Reports
 
WAL-MART STORES (WMT): Free Stock Analysis Report
 
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