Friday, May 31, 2013

Shopping for Retailing Stocks

I headed over to the Merrill Lynch offices here in Boston yesterday to learn what is going on in the retailing stocks.

Along with the rest of the consumer discretionary space, retailers have been among the market leaders so far in 2013.

Consumer spending has been surprisingly resilient despite the slow growth in the economy, and the market is apparently betting that the trend will continue.

The resurgence in housing, of course, has played a major role in the growth in retailing.  While companies like Home Depot (a name that Merrill still likes) are direct beneficiaries of improving home sales, other companies also indirectly benefit from improving consumer confidence.

Yesterday's meeting featured three of Merrill's three retailing analysts: Lorraine Hutchinson (specialty realty and department stores), Denise Chai (hardline retailers), and Robert Ohmes (apparel, footwear, and food retailers).

The story they told was somewhat mixed.  Although each featured a few stocks that they particularly favored, they were largely lukewarm on the majority of companies they follow. 

Part of the problem, I think, is that many of the companies have had a very strong run over the last year. Although there were a few exceptions, valuations on many of the stocks only make sense if you believe that the second half of 2013 will see a pick-up in economic growth.

I thought I would highlight a couple of the ideas I heard.

Macy's (M)

This has been a "home run" pick for analyst Lorraine Hutchinson, who has been bullish on Macy's for at least a couple of years.

Management has been able to maintain margins through a number of initiatives, including their "omnichannel" approach which combines traditional retailing with eCommerce. Although the company does not officially report sales channels, Lorraine feels that almost 45% of its sales comes from the internet, making the company one of the largest on-line retailers.

Trading at less than 12x earnings, Lorraine thinks that Macy's has become the best run department store in the U.S. 

Lorraine also likes the fact that management is committed to increasing shareholder returns either through stock buybacks or dividend increases.

Lorraine's price target of $52 offers only modest upside from current levels, since M is trading at around $49 a share.  However, I got the sense that she is leaning towards rising her target over the next few months.

Whirlpool (WHR)

This was analyst Denise Chan's top pick.

Although it is one of the leading global appliance manufacturers, Whirlpool is only followed by nine Wall Street analysts, which is a pretty small group for a $10 billion company.  In Denise's opinion, this represents an opportunity.

Appliance sales follow new home sales, which have been booming. Denise feels that the improvement in housing will continue, and WHR will be the beneficiary, since it has a 40% to 45% market share of the U.S. market.The stock trades at less than 10x her 2014 earnings estimate, and pays a 1.7% dividend yield.

The key to the WHR, in my opinion, is the significant improvement in operating margins that Denise is modeling in her earnings projections.  She thinks that WHR operating margins could reach by 9.5% by 2015, which would represent more than a doubling from 2012 levels.  Denise feels this is achievable, since the company has been aggressively wringing out costs and closing older facilities that are less efficient.

Denise has a price target of $140 for WHR, which would offer a pretty reasonable gain from today's price of $129.