LB LandBridge Company LLC

Right-sizing inventories and enhancing efficiencies through greater use of technology were the key agenda items on retailers’ to-do lists most of last year. Progress on those fronts has paved the way for the retailers to enter fiscal 2012 with a more optimistic outlook.

So far this year, the broader markets have showcased signs of a better pace of recovery and have thus infused hopes of a better economic scenario going forward. One might debate or disagree with this statement, but markets’ significant recovery is reflected through the benchmarks’ record-setting gains in the first quarter. The Dow and S&P 500 scored gains of 8.1% and 12.0%, respectively, in the first quarter, their biggest first-quarter gains since 1998. Meanwhile, the Nasdaq increased 18.7% in the same period, enjoying its best-first-quarterly performance since 1991.

These market gains are not baseless. Domestic economic data have mostly been encouraging since the fall of 2011. Labor and housing markets, two of the key indicators of the economy, have put up decent numbers in this period, notwithstanding some recent slips.

This has helped improve the outlook for the consumer sector as well. Therefore, joining the bull ride, retail stocks started the year on a strong note as the S&P Retail index handily outperformed the Dow and S&P 500 and jumped over 18% during the first quarter.

Retail, owing to its huge spectrum, remains a lucrative investment avenue for investors. Moreover, the sector also reflects consumer spending trends, an important parameter to gauge the health of the economy (consumer spending accounts for approximately 2/3rd of the economy). Thus, identifying future winners from this sector would be a good idea to make an investment decision.

Looking at the comparable store sales data would simplify the investment strategy as it is an important indicator for retail industry, providing an insight into future prospects.

Strong March Comparables

Easter holiday and warm weather led a majority of the retailers to register healthy sales in March.  The continuous effort to offer innovative products and value pricing coupled with their adaptability to the buying habits of the consumers and strengthen loyalties helped them post strong results.

Costco Wholesale Corporation (COST) registered growth of 6% in comparable store sales, while the topline increased 10% to $9.1 billion. A differentiated product range enables Costco to provide an upscale shopping experience to its members, resulting in market share gains and higher sales per square foot.

Moreover, the company continues to maintain a healthy membership renewal rate. Costco also remains committed to opening new clubs in domestic and international markets. The company’s diversification strategy is a natural hedge against risks that may arise in specific markets.

Macy's Inc. (M), reported same-store sales growth of 7.3%. Total sales were up 6.9% to $2,358 million. Macy’s has been taking prudent steps to increase sales, profitability and cash flows. These include integration of operations, consolidation of divisions and customer-centric localization initiatives. To help drive traffic, Macy’s continues to focus on price optimization, inventory management and merchandise planning.

Nordstrom Inc’s (JWN), a leading fashion specialty retailer in the U.S., offering high quality apparel, shoes, cosmetics and accessories for men, women and kids, registered a 8.6% increase in same-store sales for March 2012. Total retail sales were $1,029 million, up 14.7% from $897 million in March 2011.

Ross Stores Inc. (ROST), the largest off-price apparel and home fashion chain in U.S., marked a 10% increase in same-store sales in March 2012. On the back of strong comps performance, the company raised its earnings forecast for the first quarter of 2012. The company now expects earnings per share to come in the range of 89 cents to 90 cents, compared with the prior guidance of 82 cents to 86 cents. This represents a 20% to 23% increase from previous year’s earnings of 79 cents per share.

Target Corporation (TGT), the operator of general merchandise and food discount stores in the United States, marked an increase of 7.3% in comparable store sales for March 2012. Net retail sales rose 7.9% to year over year to $6,427 million.

Target’s efficient marketing, multi-channel strategy, product innovation, compelling pricing strategy and new merchandise assortments, will drive comparable-store sales and operating margins in the long term. We expect the company to gain market share, and believe that more focus on consumable items should boost sales and earnings in a sluggish environment.

Limited Brands Inc. (LTD), a specialty retailer of women’s intimate and other apparel, beauty and personal care products posted an 8% increase in comparable-store sales for March 2012. Net sales for the period came in at $840.9 million for the period. Limited Brands’ sustained focus on cost containment, inventory management, and merchandise initiatives has kept it afloat in a sluggish environment.

Kohl's Corp. (KSS), a value-oriented specialty department store offering moderately priced brand apparel, shoes, accessories, beauty and home products, reported that company’s comparable-store sales for March 2012 increased 3.6% with total sales rising 5.3% to $1,815 million.

Gap Inc. (GPS), a premier international specialty retailer offering a diverse range of clothing, accessories, and personal care products, reported an 8% increase in same store sales, a significant recovery from the prior year quarter. The company reported a 10% increase in net sales for the period.

The Road Ahead

Although the U.S. economy has started witnessing a recovery, we still believe that 2012 will not fully mark the return of the retail market. Consumers are slowly regaining confidence and cautiously increasing their spending power.

‘Transformation’ is the new mantra among the retailers. The companies are coming up with strategic initiatives to bring in operating efficiencies, drive growth and enhance shareholder’s value. Most of the retailers are focusing on abridging costs drastically to ensure competent operating channels. We believe that such measures are necessary to gain competitive advantage over peers. However, focus on improving the top-line should be prioritized to gear long-term growth.

Take the example of J.C. Penney Company Inc. (JCP). With the implementation of new pricing strategy, fresh logo, strategic merchandise initiatives, reduction in costs and enhancement of the shopping experience, management left no stone unturned to bring the company back on the growth trajectory.  The company aims to reduce costs by $900 million in the first couple of years of its transformation, resulting in lowering expenses below 30% of sales. The company targets expenses to be 27% of sales by the end of the transformation process.

Moreover, the leading specialty retailer of consumer electronic products, Best Buy Company Inc. (BBY) will pull down shutters on some stores which are not contributing to its growth, while modifications of others are also in the cards.  Best Buy, through its cost reduction program, intends to generate $800 million in costs saving by fiscal 2015, including $250 million in fiscal 2013.

The company plans to open 100 U.S. Best Buy Mobile small format stores in fiscal 2013 and intends to increase the total number of such stores to 600-800 by fiscal 2016. The strategic redirection will likely need to wait for a new management team following the recent resignation of the company’s CEO. The stock’s initial positive reaction to the CEO resignation news appeared to reflect the market’s lack of confidence in his abilities.

Consumer Behavior

As a result of the uncertain economic environment following the end of the Great Recession, the retail industry has been experiencing a shift in consumers’ shopping behavior. For understandable reasons, shoppers are spending the greater size of their wallet to buy primarily essentials and are looking for value-adds.

Across all income levels, shoppers are ranking value-for-price as the most important reason for store choices. To be competitive in this environment, the retailers are offering trend-right and well-designed assortments at compelling prices, without compromising quality, in order to drive traffic.

OPPORTUNITIES

Starting from enhancing the supply-chain management to going global, from improving their productivity through operating efficiencies to using technology, retailers are trying to cover all bases, strategically.  Retailers are focusing on cost containment, inventory management and merchandise initiatives to improve margins.

Buyer-Centric Approach: Retailers are largely concentrating on buyers’ needs, which in-turn will likely positively augment sales in the long run.  Moreover, considering the current macro-economic environment, it is a smart move as it better positions companies to attract consumers.

Multi-Channel Strategy: The technological advancement in marketing, such as e-commerce and m-commerce, creates a win-win situation for both the retailers and shoppers, as it enables the companies to generate additional sales and broadens the company’s existing customer base throughout the world.

Moreover, this strategy also enhances the visibility and reputation of the retailer as a global firm. Shoppers get the benefit of purchasing researched products at better price-points, as they can compare prices being offered by various companies.

New Markets: International turf and emerging markets provide ample opportunities for retailers to widen their growth prospects and help the companies to hedge against economic cycles.

Store Formats: In order to enhance the shopping experience of customers, retailers felt the need to adapt to the demands of time and consider consumer-oriented strategies. Target Corporation (TGT), in order to tap the urban markets where real estate remains a constraint, plans to introduce smaller-format stores called City Target.

In a similar move, Cabela’s Inc. (CAB), one of the leading specialty retailers of hunting, fishing, camping, and related outdoor merchandise, unveiled its new ‘Outpost’ store format. The relatively smaller size store will provide shoppers with Cabela's retail experience and will facilitate the company to capitalize on the under-penetrated markets.

Business on the Rise

Dollar Discount Stores: The dollar discount stores have performed well when the recovery in the economy seemed tough, generating top and bottom line growth. Family Dollar Stores Inc. (FDO), the operator of self-service retail discount store chains, remains successful in luring consumers to its stores.

We believe that the company’s effective pricing and inventory management, private label offering, expanded operating hours and merchandise initiatives should drive sales. The company’s point-of-sale technology and store realignment initiatives better position it to drive traffic, meet customer-oriented demand and improve in-store shopping experience. Family Dollar now expects fiscal 2012 net sales to jump by 9% to 10%.

WEAKNESSES

Retail is highly competitive and has significant challenges. Although the economy is showing signs of improvement, it still lacks clear visibility. The sense of uncertainty will continue to weigh upon consumers’ sentiment.

Moreover, consumers remain sensitive to macro-economic factors including interest rate hikes, increase in fuel and energy costs, credit availability, unemployment levels and high household debt levels, which may negatively impact their discretionary spending, and in turn adversely affect the growth and profitability of companies.

Beyond the macro factors, rising inventory levels and higher input costs remain a drag on the margins of retailers. Further, fashion obsolescence remains the key concern for retailers as this may lower the comparable-store sales and deplete margins.

The Final Verdict

The players who will be able to cater to the needs of consumers will grow volumes by ensuring foot falls and margin expansion.

Further, the ratio of converting shoppers to buyers will also rest on the continued economic recovery and improvement in the job market. This will ultimately boost consumer confidence and increase spending.
 
BEST BUY (BBY): Free Stock Analysis Report
 
CABELAS INC (CAB): Free Stock Analysis Report
 
COSTCO WHOLE CP (COST): Free Stock Analysis Report
 
FAMILY DOLLAR (FDO): Free Stock Analysis Report
 
GAP INC (GPS): Free Stock Analysis Report
 
PENNEY (JC) INC (JCP): Free Stock Analysis Report
 
NORDSTROM INC (JWN): Free Stock Analysis Report
 
KOHLS CORP (KSS): Free Stock Analysis Report
 
LIMITED BRANDS (LTD): Free Stock Analysis Report
 
MACYS INC (M): Free Stock Analysis Report
 
ROSS STORES (ROST): Free Stock Analysis Report
 
TARGET CORP (TGT): Free Stock Analysis Report
 
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