RETAIL STOCK OUTLOOK: Solid Thanksgiving Weekend and November Sales
07:52am EST 2-Dec-97 DLJ Securities (Gary Balter) DH COST WMT SPLS OMX ODP LOW
DLJ ****** DONALDSON, LUFKIN & JENRETTE ****** DLJ
December 2, 1997 Gary Balter (212) 892-4228
Doug Donovan (212) 892-8906
Jeff McMahon (212) 892-2351
RETAIL STOCK OUTLOOK
Solid Thanksgiving Weekend and November Sales
Retail Inventories In Check; Strong Margins
Positive Outlook for Holiday Season
RATING: Outperf. Change: None
VIEWPOINT
o Solid Thanksgiving weekend sales drive November sales gains
o Positive outlook for fourth quarter results, with inventories
remaining tight and margins still robust
o Third quarter retail earnings show sector strength
o Overweight the Retail Sector
We continue to recommend an overweighting in retail. The holiday shopping
season was kicked off solidly this Thanksgiving weekend, giving us more
optimism for the upcoming December and fourth quarter sales. Especially
strong sales were seen at the discount stores, specifically Target (DH#)
and Wal-Mart#. With third quarter results at or above expectations and
positive November sales trends, we have more confidence in a solid fourth
quarter.
We have a favorable outlook on retailers this Christmas, as consumer
confidence is high, disposable income is up, and interest rates are low.
Moreover, retail stocks continue to enjoy solid sales momentum into the
fourth quarter, while maintaining tight inventories and expanding margins.
With earnings growth expected to be better than the market, easy earnings
comparisons, and reasonable valuations, retail remains one of the best
sectors to invest. We continue to expect investors to search for safe
havens and retail stocks should outperform the market with the larger cap
discount stores, the computer, office supply and consumer electronic
retailers and selected other specialty retailers being the best performers.
That said, we would expect some profit taking after days like yesterday,
where many of these retailers rose in the 5% plus range. We prefer slower
steady increases that have been more the norm since the market correction.
We remind investors who are worried over the recent move in retailing that
many of the stocks, most noticeably Dayton Hudson, Circuit City#, and the
department stores still trade at discounts to the market and to their
relative growth rates. The best stocks for this Christmas season will be
the larger capitalization names that can provide earnings growth
visibility. That group includes Wal-Mart, Dayton Hudson, Costco*++@+, Home
Depot#, CompUSA#, Office Depot#, GNCI*+ and Borders+ from the hardlines
and discount stores.
NOVEMBER SALES TRENDS (to be reported in more detail on Thursday, December
4th):
o Dayton Hudson#. Overall, November sales were strong. Specifically,
Mervyn's sales were well above its low-to-mid single digits plan, the
department stores were well above their flat expectations, and Target was
on-plan with its low-to-mid single digits. Sales for the Friday and
Saturday of Thanksgiving weekend were in-line with overall monthly trends.
The importance of that announcement is that it marks the second month of
solid results at Mervyn's and Department Stores. Continued solid sales at
these two divisions not only imply that the estimates are too low, but
would revise the projected growth rate over 15%. That would lead to a price
target closer to $90 over the next twelve months leaving significant
upside from its current level. DH remains our favorite discount store
investment.
o Home Depot#. We believe November sales were in-line with the previous
guidance given at the end of the third quarter, as sales are estimated to
have comped solidly in the mid-single digits. Home Depot does not give out
monthly sales numbers (they report only quarterly).
o Lowe's#. November sales were on the low end of plan, with sales
running similar to their third quarter results. Margins should continue to
expand as a result of Lowe's continued expense reduction efforts and a more
favorable product mix. The company plans on achieving a 5% sales comp for
the fourth quarter.
o Wal-Mart#. Wal-Mart was quite pleased with its weekend results, with
sales in line with its mid single digit expectations and margins stronger
than a year ago. We expect that Wal-Mart will report sales for the month at
the higher end of plan, and we are very comfortable with the fourth quarter
consensus estimates. Not surprisingly, this stock continues to rise as it
represents the safety that investors are looking for as they search out
retailers.
o Sears#. Sears enjoyed a solid weekend with hardline sales very
strong, although apparel was lighter than plan. The stronger sales should
push Sears total comps into positive territory, with appliances, hardlines
and furniture leading the positive results. Automotive continues to trail,
primarily reflecting the transformation of Western Auto stores to Parts
America format. Credit losses are likely to limit Sears earnings growth
this quarter and we do not view this stock as the ideal near term way to
play the evolving better margin story that we discuss above.
o Office Supply Stores/ CompUSA/ Consumer Electronic Chains. Promotional
activity in the computer sector was noticeably subdued this weekend,
implying possibly lower sales, but higher gross margins and gross profit
dollars than last year. We also believe that office supply and related
sales were strong this weekend. We continue to strongly encourage an
overweighting in these stocks, with our favorites being CompUSA, Circuit
City, and the office supply chains. Office Depot's stock decline yesterday
the result of a large block trade makes that stock the most attractive near
term trading stock.
OVERWEIGHT RETAIL:
The reasons behind our retail overweighting, as we detailed in our November
25th comment, include:
1) Solid November Sales. The retailers have shown all year that they only
need in-line sales to make or beat earnings expectations because of the
focus put on the margins. This quarter should be no different and with a
solid start in November, and with no signs of any irrational pricing, the
retailers are in excellent position heading into Christmas. Obviously,
December will be the crucial month, but we remain confident that retailers
will continue to perform well.
2) Universe Remains Cheap Relative to Market Despite Earnings Prospects
Better than for Market. Despite what has been a strong move this year, the
major retailers are still undervalued on a relative basis. With the market
trading at over 20 times next years earnings, retailers are trading below
18 times. With easy comparisons and higher projected growth rates, we
expect that retailers will report better year over year increases in
earnings.
3) Low interest rates and a consumer with some money in her pocket. While
the recent market gyration may have scared a few, many are coming away with
the sense that the fundamentals of a solid economy are in place and that
the overall macro picture favors retailers. Consumer confidence is high,
disposable income is up, interest rates are low, and Christmas is coming.
All of these point to potential strong retail performance. The risk to this
scenario is a loss of confidence because of an overseas economic meltdown,
but that to date is not as visible or topical to Americans.
4) Focus has shifted from gaining share to gaining profits. Retailers are
not using aggressive pricing to gain share from other retailers. Wal-
Mart#, the entity that often dictates what the environment is like,
indicated that gross margin line continues to be a focus for them, implying
they are being less aggressive with their pricing strategy. This does not
mean that there are no price wars, merely that the environment is much more
friendly than it has been in the past. As a result, retailers are showing
improving results on the gross margin line.
5) Tighter inventories and expense rationalization. With the focus away
from gaining share, retailers are putting more emphasis on leveraging
suppliers. This means more demand on the manufacturers to have merchandise
ready when the retailers need it, saving the retailers considerable amounts
in inventory costs. Even with the lighter sales numbers, most retailers
are indicating that inventory levels are fine. There were few out of line
inventories reported with the third quarter results, giving us more
confidence for fourth quarter margins.
6) Few retailers have any significant exposure to the Asian markets or
currency. In a market that is increasingly worried about the effects of
currency devaluation and market fluctuation, these domestic retailers offer
a safe-haven from such concerns. Certain specialty apparel retailers have
international exposure, but that is the exception rather than the rule. In
hardlines, Toys R Us# has the most foreign exposure in our retail universe,
with no other retailer dependent on non-North American earnings for more
than 5% of results. We also discussed the positive impact on gross margins
from lower costs overseas earlier.
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