Monday, June 2, 2008

Enough already!

Is there no end to the pain and insanity in retail land? It's just WRONG when the economy is so bad that even a can't-lose retail concept like Lululemon has to take down earnings guidance. Seriously, what could possibly be more mission critical to Jane Consumer than spendy yoga togs? It's a trend that is a bit concerning. It was just last week that another high-end Wall Street darling, J Crew, also had to bring down guidance.

I have sick sense of humor sometimes, but I find it tremendously amusing that if the company is growing its store base and appeals to an upper income demographic, Wall Street loves it. As if $4 a gallon gas will never affect people who make over $100k a year. Let's be real folks - the only way this economy isn't putting the squeeze on you is if you don't eat or use energy. And those folks above the US median income level (which is roughly $47k/year), in many cases those are the folks that stretched themselves even further beyond their means and are hurting more now.

So how on earth does someone invest in retail stocks right now, given all that? First, one takes a heavy dose of one's favorite antacid. Then, the next step is to determine your personal outlook on the economy. (You might want to take another swig from that Maalox bottle right about now.)

If your economic glass is half empty, think about where people either shop to save money or have to shop to survive. I'm a personal believer (and holder) of companies that sell food and other consumables such as Wal-Mart and Costco. I'm hard pressed to find a stock that I like more than Wal-Mart. Really. Wal-Mart. They've finally shifted the majority of their marketing away from that hideous bouncing smiley face and it's unhealthy obsession with dropping prices. Don't get me wrong, consumers absolutely need low prices right now. But they're not so desperate for low prices that they would endure the seven levels of hell that a shopping trip to Wal-Mart used to involve. Thank goodness management finally brought some fresh blood into their little closed world of NW Arkansas, and exciting new ideas such as 'even people on a budget like to shop in a nice environment,' and 'if people aren't in a rush to leave the store, maybe they will spend more money on discretionary items' started invading the corporate consciousness. Revolutionary, no?

Retail today is more than the old adage 'stack it high and watch it fly.' Retail is both art and science. For years, Wal-Mart excelled at the science of retailing - selling stuff cheap and controlling costs. Watch the CNBC documentary "The Age of Wal-Mart" sometime. The fact that they even know that strawberry PopTarts sell best before a hurricane scares me. Even scarier: that it took them so long to understand that a clean bathroom and short checkout lines make for happy consumers. And who would have ever guessed that putting up little signs that show us what an outfit should look like would sell more clothing? Oh yeah, the competition.

Which brings me back to how Wal-Mart has changed. As one Wall Street wonk put it recently, "this isn't your father's Wal-Mart." They have made strides on employee health care and the environment, both of which were causing issues with and for investors. They finally recognized that growth for growth's sake wasn't working. US retail domination via copious store count growth is no longer a stated goal (although World Retail Domination still seems to be on the table.) Thinking about Return on Investment is back in vogue at headquarters. And the arrogance that management once displayed toward their critics seems to have been at least muted if not dissipated entirely. Thank you Leslie Dach and Eduardo Castro-Wright: whatever they're paying you isn't nearly enough.

So there are all the touchy-feely reasons for owning the stock. The bottom line for a capitalist is buying the stock low and selling higher. Wal-Mart is currently trading at 16.7 times January 2009 consensus earnings of $3.45. Personally, my model puts earnings at $3.51, or a P/E of 16.3x '09 estimates. I am looking for P/E multiple expansion (investors willing to pay higher prices for a similar level of earnings) as it becomes more and more obvious that Jane Consumer isn't going back to her lavish lifestyle any time soon. Last year's aspirational consumer is now aspiring to put food on their table and gas in their tanks! I'm guessing that at least a 18.5x next year's earnings is reasonable, or about $65. If they continue to deliver strong sales and earnings, that number may experience inflation too.

Next time: where to look for investments if your economic glass is half full.

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