3 Retail Stocks You Need To Sell

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

The financial health of the American consumer clearly has pulled back a little. Earlier last week, we saw a lackluster gain in retail sales that was propped up by strength in autos, pointing to cutbacks in other things like restaurants and electronics.

Of course, as exciting as it is to find companies that can grow even in a tough environment, it is equally important to find those retailers that should be avoided because of weak fundamentals. These stocks will get hammered if the consumer slowdown continues — thus, you must either sell or avoid them until their fundamental conditions improve.

A hot retailer cools off

Aeropostale (NYSE: ARO) was once a hot growth stock, but it seems to have lost the always-fickle teen market. Although management is said to be scrambling to find the styles that recapture the market, the jury is still out on how successful Aeropostale will be going into the critical back-to-school shopping season. Sales have been flat all year, and analysts have been lowering their estimates for this year and 2014. Portfolio Grader downgraded Aeropostale shares to an “F” back in March, and issued a "strong sell" recommendation. 

While merchandise at Aeropostale has progressively improved over the past 12-18 months, the retailer remains in the grasp of an aggressive discounting cycle that it seemingly cannot break free from in efforts to win over to the growing cost-savvy consumer. This deep-discounting program certainly has achieved what it was meant to do - boosting merchandise sales by 7% - but if rumors of its end are true, Aeropostale will not be able to sustain its recent progress. On the bright side, the retailer signed a licensing deal with Distribuidora Liverpool SA de CV that will enable Aeropostale to open shops within Liverpool department stores across Mexico, but many are unsure as to how it will do within the Mexican demographic. 

Can this company turn it around?

The financial media has been talking of the potential for a turnaround at JCPenney (NYSE: JCP) for well more than a year now. It has not happened, and the retailer has changed directions once again. If JCPenney is ever successful in righting the ship, those improvements will show in Portfolio Grader — but that time is not now. JCP has had to tap into its credit lines to provide operating capital and likely will have to raise more capital before much longer.

JCPenney last released its earnings in May, missing the analysts’ consensus estimate of ($0.86) by $0.45. Eight analysts have rated the stock a sell, and 12 have assigned a hold rating. Additionally, news broke in early May that JCPenney stores were quietly placing new stickers over their old prices, often doubling the price, then marking it down as a "sale." Simply put, JCPenney is a lottery ticket given its current state. I recommend to stay away from JCPenney until it can provethat it's the revered retailer it use to be.  

Little margin for error

For Kohl’s (NYSE: KSS), the third quarter is historically the second-highest for sales but only the third-highest for profits, suggesting the company relies on bigger back-to-school markdowns than other retailers mentioned.

Unfortunately, relying on discounts can cut both ways. Since Kohl’s loves back-to-school sales, it will get more penny-pinching shoppers this season. At the same time, you could also posit that its customers pinch pennies more to begin with. If the latter is the case, Kohl’s could feel the sting of higher electricity bills even more than some rivals.

Either way, there’s not much room for error. Kohl’s is currently slated to post a mere 1.4% improvement in sales during the upcoming quarter, and a 4% improvement in profits. Any softness in those numbers could lead to a sales decline or earnings miss, either of which could prompt a significant sell-off.

A bright spot: Kohl’s is one of the few retail stocks that actually boasts a decent dividend — consistent income perfect for bumps like a short-term back-to-school swoon.

Foolish bottom line

Retail stocks in general are not the popular choice for investors in today's economy, and the aforementioned stocks are certainly not the preference of the general populous. If the three companies above want to get back on track, they must make some alterations, but nonetheless, investors should still keep on eye on them. 

The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.

Chris Johnson 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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