Are retail stocks a good buy?

The mob scenes you may have experienced at your local department store are a good clue that shopping is still brisk – and a sign that the department store segment of the retail sector, from an investment standpoint, remains healthy.

Sure enough, department store stocks have been outperforming the market lately – and even outpaced broader indices in 2004. And retail stocks have generally moved higher as investors have embraced solid sales results, driven currently by teens and high-end shoppers.

Given the retail sub-sector’s momentum, should investors shop for department store stocks? To answer this question, we need only to look at the group’s investment outlook. According to many industry analysts, the sub-industry’s outlook is neutral due to a number of negative and positive fundamentals:

On the negative side:

• Increasingly difficult sales and earnings comparisons (given lacklustre sales of basic products)
• Growing consumer concerns over labour costs
• Prospect of higher energy costs
• Possibility of rising interest rates

On the positive front:

• Trend towards an increased merchandising focus on fashion apparel (in response to the lacklustre sales of basic products)
• Prospect of lower promotional costs (i.e. discounts) that lure customers (if stores can pull off the introduction of a wide choice of trend-right products)
• Renewed focus on customer relationship management (CRM) systems (such as in-store fashion experts for customers) that build stronger emotional ties with the consumer (who has responded well to this trend)
• Favourable response of time-strapped consumers to expanded online selections and off-mall expansion

From a negative perspective, there are factors that could dampen the sub-sector’s financial results in 2005. This suggests that the healthy performance of department store stocks may not continue in the coming months. In other words, the group’s fundamentals may not necessarily justify its current momentum.

From a more positive standpoint, department stores that remain focused on factors within their control – such as product, pricing and service levels – may have stronger-than-expected results in 2005.

Some of the stocks that fall into this group include the following: Best Buy, Canadian Tire, Federated, Hudson’s Bay, J.C. Penney, Kohl’s, May Department Stores, Nordstrom, Saks, Inc., SearsRoebuck & Co., Sears Canada, Target and Wal-Mart Stores.

June 2005

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.