Searching for the Next Great Retail Stock
Shawn is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Back in January, I wrote an article here on the Motley Fool Blogging Network which attempted to show that restaurant stocks are a good place for growth investors to examine because their business models allow for rapid expansion. Investors should also keep an eye out for companies in the retail industry because they have similar models and can often result in great returns for shareholders.
Take Lululemon Athletica (NASDAQ: LULU), for example. The company specializes in selling high end athletic apparel (mainly expensive yoga pants) in the US, Canada and Australia. LULU has grown revenues from $400 million to over $1 billion in just three years. The company accomplished this feat by expanding their store base 40% and generating an impressive 25% average same store sales growth. Furthermore, LULU managed to increase gross margins through pricing power. For all this effort, shareholders have been rewarded with multiples of their original investment.
Will investors easily be able to find the next LULU? I don’t believe there is a retail stock available that exhibits the neck breaking growth that LULU has shown over the past three years, but two stocks that are worth noting, Genesco (NYSE: GCO) and DSW (NYSE: DSW), show excellent potential to demonstrate above market returns. Let’s take a closer look:
Genesco
You are probably not familiar with this company based upon its corporate name. But you are probably familiar with their brands: Journey’s, Johnston and Murphy, Underground Station and Lids. The most intriguing of this group is Lids, the ubiquitous operator of stores that sell professional sports related hats and accessories, which is approximately 38% of GCO’s sales in FY 2011.
Lids is going to be the center of growth for the company over the next few years and should be what shareholders monitor. The chain is increasing brand awareness and consumer relationships all while maintaining an efficient smaller presence at its 1000+ locations across the county. Every Lids store operates at about 1,075 square feet, or roughly ¼ the size of traditional retail outlets. Lids is currently 12th among retailers in sales per square foot at $706 (see chart below.) This operating efficiency allows the company to maintain operating margins above 10%. As the company continues to improve their operating performance, it is feasible that management could grow operating margins into the mid teens. Increasing margins to 15%, let’s say, would add approximately $0.50 per share in earnings to the company. Trading at only 14x next year’s earnings, the company could be a bargain at these prices.
Source: Non Lids data found at 9To5Mac.com
DSW
Men probably get the chills just by the sheer mention of this store. The company sells designer and branded shoes at over 325 locations in the US. The company doesn’t operate your typical small shoe store, DSW stores are massive; often averaging around 22,000 square feet of retail space. This large retail presence allows the company to carry a lot of inventory providing consumers with a variety of shoes and the convenience of self service. The model has worked well as DSW has grown sales from $1.1 billion in FY 2005 to over $2 billion in FY 2011 and net income from $45 million to $132 million.
What excites me is that management of DSW has a realistic plan to double earnings by 2015. Their plan relies on factors like market share growth, expansion in the western part of the country and a smaller store footprint for better economics. Can management achieve their goal?
The company only captures about 4% of the $50 billion per year adult footwear business. Given the large number of competitors in this industry, it is unlikely the company could gather much more than a 10% market share by 2015. But even at 10% that is still over double the share that they have currently. Share gains could come at the expense of current direct competitors but also into expanded business lines. DSW generates about 66% of their sales from Women and only 15% from Men. The company could increase their inventory or adjust their advertisements in order to cater to the Male consumer. Any increase in sales of Men’s footwear would help the company gain market share.
The company could also increase market share by expanding their store presence. DSW has about 70% of their locations east of Texas (see map below.) Given the large size of each store, management has been wise to expand within their means, only opening about 125 stores since 2005. That same level of growth could provide the company with ample sales while maintaining a sustainable capital structure.
Source (DSW)
DSW plans to follow the trend in retail and reduce the size of their footprint creating cost savings through more efficient operations. Their smaller stores will be 18,000 square ft and will target slightly smaller markets. The initial investment is less than their traditional stores and is projected to increase sales per square ft by 10%. The smaller stores should also result in greater cash flow generation and returns. Both would be welcomed by shareholders.
Discussion
What retail stock do you think is primed for growth? Share them in the comments below!
Shawn Robinson is also on Twitter.
ShawnRobinson has no positions in the stocks mentioned above. The Motley Fool owns shares of Lululemon Athletica. Motley Fool newsletter services recommend Lululemon Athletica. 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. If you have questions about this post or the Fool’s blog network, click here for information.
