3 Retail Stocks to Buy on Bottom-Line Expansion

Masam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Recently, I have been writing on a few well known names in the hard-line retail industry. My focus has been especially on players in the retail-automobile industry. This article also briefly discussed two retail-automobile players. However, this time the focus is not only on rising sales due to a rising US SAAR (which is the car sales in the US), but also on bottom-line improvement due to efficiency. Taking advantage of this theme in retailers (I mean bottom-line expansion), I have taken the liberty to add a non automobile retailer to the article that is expected to witness bottom-line expansion in the future.

Lithia Motors (NYSE: LAD): Lithia remains one of the favorite small-cap names in the retailer industry. Lithia Motors offers among the greatest earnings upside to improving new vehicle SAAR and has meaningful organic and acquisition growth potential, which combined with its sector-low valuation make it a compelling story. Calculations show a 10% potential upside to 2013 numbers on stronger sales and expense leverage.

There are several key strengths to the story: The company’s market exclusivity, substantial expansion potential, and rigorous expense disciplines, which are driving the company’s industry-leading flow through, seem some attractive points to bulls. CEO Bryan DeBoer’s intense focus on analytics, personnel, and execution should help the company further enhance its efficiency in 2013. I recommend the stock as a buy. Credit Suisse has a current target price of $50 on the stock, which is ~17% upside from the current levels.

Penske Automotive (NYSE: PAG): Penske is poised to perform well in 2013. The company is coming off one of its best results in 2012, despite having inventory issues with a couple of key brands. Comps were strong, gross profit per unit was resilient, and expense leverage showed improvement. The company’s European business, while not as strong as the U.S., performed surprisingly well despite economic and inventory issues. More of the same is on tap for 2013 from a sales and margin perspective.

In addition, the company is slowly buying out some of its leases, which should result in positive earnings arbitrage while enhancing operating leverage. The expensive leases are being converted into less pricey mortgages, eliminating the associated rent expense and dropping a smaller amount of mortgage interest below the line. The Street estimates mid-teens to high-teens EPS growth for the company in 2013 and believes that the stock should be up a similar amount. Credit Suisse has set a target price of $38, which means an upside of ~20% from current levels.

Dick’s Sporting Goods (NYSE: DKS): Dick’s Goods is relatively well-positioned to outperform in 2013, even though the weather will likely not be a friend for the second year in a row. The company’s healthy product trends (absent the weather noise) combined with a number of gross margin drivers could lead to upside to the current consensus estimate of $2.92 in 2013. The system improvements present the most significant opportunity in 2013 and 2014, as the company focuses on regional pricing and better markdown management. In addition, margins should benefit from continued growth in private label, significant price optimization, zone pricing, and regional merchandising opportunities, which should move margins through the 10% range in the near future.

While the stock has moved back up, the stock is still trading below a 17x multiple on FY 14 consensus EPS. The current valuations could point to another 5-10% upside to the stock. However, past the near term, risks include improvements and/or accelerating store growth of direct big box competitors, rising e-commerce penetration in the sporting goods category, including moves from Amazon, and premium brands focusing more on direct distribution or expanding distribution to other channels. These threats could become material later in 2013.

Foolish Bottom Line

Bottom-line expansion seems to be a common theme in the retailers, which is expected to bring a rally in this industry in 2013. 


AnalystX has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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