Retail Stocks May Be Ripe for a Trimming
Nov 08, 2018
Retail has had a great year, but is it time to take some chips off the table?
Where we were: The SPDR S&P Retail ETF (XRT) is up nearly 10% in 2018, easily outpacing the broader market.
Where we’re headed: Research firm Gordon Haskett argues that investors should adjust their exposure to the industry lower, given tougher times ahead.
Retail has had a great run in 2018, stemming from the robust 2017 holiday season. The problem is that the current round of optimism kicked in just about a year ago, setting up more difficult comparisons for the group, which has already had a strong run.
Given this backdrop, Gordon Haskett’s Chuck Grom anticipates a “cooling/transitional period...as we turn the corner into 2019,” leading him to suggest investors “modestly reduce” their long-term exposure to retail. That includes downgrades for Lowe’s (LOW) and RH (RH) to Hold, with price targets of $95 and $135, respectively, down from $117 and $172. He downgraded Nordstrom (JWN) to Reduce, but kept the $55 price target.
Grom points to the uncertain impact of tariffs, the widening spread between current consumer confidence and consumer-confidence expectations (“the worst since 1999”), rising interest rates, and the concern that shoppers have already spent much of their windfall from lower taxes and rising wages.
This may sound like a bear-case scenario, but Grom isn’t there quite yet, writing that “there are reasons to stay optimistic.” After all, his latest survey showed that consumers are still upbeat about current business conditions and the job market, and while last year’s holiday season was a strong one, we could see weather tailwinds this year. Moreover, Social Security cost-of-living increases and child-tax-credit changes could put more money in some shoppers’ wallets, and we’ll soon begin lapping the increase in transportation costs, which has been a drag for the industry.
Therefore, while he recommends taking some money off the table, he still thinks it’s worth investing in retail, using a barbell approach. “More specifically, on the defensive side of the barbell, we continue to recommendDollar General (DG), Home Depot (HD), Tractor Supply (TSCO), Costco Wholesale (COST), and BJ’s Wholesale Club Holdings (BJ). Conversely, on the offensive side, we continue to like Five Below (FIVE), Macy’s (M), Kohl’s(KSS), Target (TGT), and Floor & Decor Holdings (FND),” Grom writes.
Now for the bad news—the downgrades. In terms of Nordstorm, Grom writes that while he’s long been a fan of the company’s model and strategy, he warns that the valuation looks too high, especially with competitive pressures in today’s market. That makes him more cautious, although he’s careful to stress the downgrade isn’t a call on the company’s upcoming third-quarter earnings report, due next week.
As for Lowe’s, he writes that the stock’s big run—and recent data pointing to a softening housing market—means it’s time to take some profits. He believes that higher interest rates and a supply-demand imbalance will dampen remodeling activity. Given what he sees as a fair valuation, he prefers Home Depot, which is “investing offensively and better positioned to navigate a potentially choppy backdrop,” instead.
RH faces similar headwinds, although Grom notes its well-heeled customer base was likely more affected by October stock-market volatility than that of other stores, and a general reluctance among consumers to take the plunge of big-ticket items.
XRT is up 1.5% to $49.80 in recent trading.