Take Advantage of the Retail Industry Shake-Up

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Foot Locker (NYSE: FL) and Ross Stores (NASDAQ: ROST) are two Wall Street darlings within the retail sector that reported key data last week.

While operating in different lines of retail, both stocks are similar in regard to the high expectations for same-store sales, market share gains, and earnings growth.

To set the bar for optimism at the highest level, the Wall Street community advised clients that Foot Locker and Ross Stores should be able to outperform the high end of consensus guidance. In addition, both stocks were advocated as a trade---buy each stock before the news is announced, and sell the following morning for a quick profit.

When both companies met the high expectations but didn’t exceed them by a wide margin, market participants responded with a textbook “sell the news” reaction. This reminds me of earning an A+ grade on a difficult high school calculus exam, but somehow managing to miss the bonus question.

Let’s take a look at each company and determine if the subsequent sell-off was warranted.

Foot Locker

Foot Locker reported adjusted earning-per-share of $0.73, meeting analyst estimates of $0.73 to the penny. Fourth quarter revenue of $1.71 billion exceeded the consensus figure of $1.69 billion, and same-store sales grew a massive 7.9% for winter 2012 compared to the 2011 season. Sounds good to me, right?

Following the athletic retailer’s A+ report card, market participants sent the stock lower by more than 7% on Friday, March 8.

Here are four reasons the market is providing you with a great buying opportunity in Foot Locker:

  • Fundamentals are strong. Foot Locker is gaining market share and attracting customers from Finish Line, which has a similar mall-based store format but weaker basketball category. Basketball sneakers are an emerging athletic and social fad, and Foot Locker is capitalizing on the trend.
  • Analysts on Wall Street believe management’s earnings estimates are conservative. The company has surprised on the upside in at least 7 of the last 8 quarters, going back to May 2011.
  • In the wake of the 7% post-earnings sell-off, the stock is trading at 13.5x price-to-earnings. Revenue has grown 8.3% in the last 12 months, while earnings have grown 48%.
  • Foot Locker approved a $220 capital expenditure plan for 2013, an increase over the $163 million spent during 2012 and a testament to the strength of the new store format. The company opened 85 new stores and remodeled or relocated 198 stores during 2012.
  • The board of directors recently approved a new capital allocation strategy for 2013. Foot Locker increased its quarterly dividend to $0.20, and announced a new 3-year $600 million share repurchase program that extends through January 2016.

Ross Stores

On Thursday, March 7, the discount clothing retailer reported that February same-store sales declined 1% compared to the prior year. This compares with a January report which indicated that SSS increased 4%. Once again, market participants reacted by selling the news, sending shares of Ross Stores lower by more than 7% on March 7. Shares recovered a portion of the losses on Friday, March 8 with a 1.76% gain.

Here are four reasons why Ross Stores is a great long-term buy at current levels:

  • The same-store sales decline could be attributed to the delay in income tax refunds, as the company noted that sales improved as the month progressed. Furthermore, the comparison was difficult, as February sales roses 9% during the 2012 calendar year.
  • Investors took little notice that sales actually increased for the month, to $726 million for the four weeks ended March 2, 2013 compared to $707 million the prior year. The increase can be attributed to store expansion; 1,091 stores opened this year compared to 1,037 during February 2012. The $12.5 billion retailer opened 2 new stores in Hawaii as recently as this past Friday.
  • Analysts at Piper Jaffray lowered their price target from $86 to $71 on Ross Stores, a secondary reason for the temporary sell-off. However, the investment firm is still optimistic. The new price target is 26% above recent market prices.
  • Revenue has grown 12.0% in the last 12 months, while earnings have grown 22.6% during the same period. According to data from Capital IQ, analysts expect earnings to grow approximately 14% annually during the next 5 years.

Retail Industry Shakeup

Both Foot Locker and Ross Stores are benefiting from a shake-up in the retail industry. In particular, Ross Stores is benefiting from a transition at Kohl’s Stores (NYSE: KSS) and a restructuring at J.C. Penney.

On March 6, Kohl’s announced the opening of 9 new stores, bringing its total store count to 1,155 stores across 49 states. Although Kohl’s shares have risen 8.5% year-to-date, the stock has declined 7% in the last year.

Wall Street analysts believe that Kohl’s Stores could become a leveraged buyout (LBO) target. The company has strong free cash flow and is priced attractively at 11x earnings. Kohl’s also owns a substantial amount of real estate.

Foot Locker, Ross, and Kohl’s are all benefitting from weakness at J.C. Penney, which experienced a massive 31.7% same-store sales decline. These customers haven’t disappeared--they are simply spending their dollars at other retailers.

Foolish Bottom Line

Experienced investors know that price action is driven by market sentiment and emotion. Traditional investors have a great buying opportunity in Foot Locker, Ross Stores, and Kohl’s Stores. In contrast, the likelihood of a JC Penney turnaround is becoming increasingly slim.

Thanks for reading, and consider subscribing to my posts for more Fool ideas on outperforming the market.

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