2 Retailer Stocks to Buy, 1 to Sell
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
With the economy still largely uncertain, investors have reason to be on the fence about retail. However, this has caused strong brands, like Target (NYSE: TGT), to become overly cheap and attractive to many investors. Others, like Wal-Mart (NYSE: WMT), have been viewed as defensive recession-proof investments for some time and still have upside from here. Still others, like Costco (NASDAQ: COST) look plain overvalued. In my view, one of the best retail portfolios would consist of positions in consistent growers and undervalued light-risk stocks. At the end of the day, no one wants to be left holding the negative effects of stagnant (or, worse yet, declining, incomes). Accordingly, I am not exceedingly optimistic on the retail industry, which is the direct connection for consumer expenditures, but do recommend a few picks.
Target, in particular, has always attracted me. While everyone knows Wal-Mart for its large monopoly-esque business influence, few appreciate the fact that Target is the second largest domestic discount retailer. That's an incredible feat that comes with a powerful brand. Over the past 12 months, shareholder value has gone up 22.1%, and the stock price is now near its 52-week high. Even still, the multiples are compelling. Trading at a respective 14.7x and 13.2x past and forward earnings (slightly above the historical 5-year average PE multiple of 14.2x), Target has succeeded in turning around the business. Weakness during 2007 and 2008 was ultimately turned into a 24.2% EPS CAGR over four years. This trend has been under appreciated by the market, which has held Target's shares flat over the last 5 years. At the same time, management has showcased confidence over the fundamentals by continuing to increase dividend distributions, which now put the yield at 2.2%.
In contrast to Target, Wal-Mart has gone up a significant amount over the past 5 years: 70.7%. In my view, Wal-Mart's multiples don't do justice to the firm's investment value. When you consider that Wal-Mart may very well be the strongest company in America, it's odd that the company is only valued at nearly just a third of Apple's market cap. That's a significant disparity, especially considering that Wal-Mart is brand that is here to stay while Apple, just like Microsoft, is exposed to intense competition. Yes, retail is still an intensely competitive industry, but Wal-Mart has its business down to a science, and it knows how to get razor thin margins to keep long-term profit bright.
In particular, Wal-Mart is seeking to expand into emerging and unconventional markets through alternative means. India recently gave firms like the world's largest retailer the rights to own controlling stakes in local ventures. Communities may have protested Wal-Mart's effort to open a store in Brooklyn, but consumers are much more willing to acquiesce at the low-cost checkout counter than activists will have you believe. That is to say, Wal-Mart will always face pressure over its supposed "predatory prices", but, in the long-term, the retailer will gain support from those looking to maximize the lot of consumers, particularly low-income ones.
I am particularly optimistic about the firm's ability to brand itself as a grocer. It already has the fourth largest market share in the grocery industry, and penetration in Chicago has set the tone for consistent gains going forward. Stores could be much larger than most state grocers and attract in those seeking food staples at the cheapest price. While Wal-Mart has done a good job at dismissing the principal of "prestige pricing" for consumer goods, it has yet to really do the same for food items. With workers uncertain about their future, they are willing to save money on almost anything, including the basic necessity of food.
Under such a climate of "give-us-low-prices," it is surprising that Costco receives merely a "hold" rating on the Street. But upon careful analysis, it becomes clear that the stock (perhaps unlike its products) does not give you a good bang for your buck. It trades very high at a respective 28.5x and 23.1x past and forward earnings - multiples that offset any short-term appreciation that would have otherwise come from the realization of annual earnings growth.
Analysts forecast Costco to increase EPS by 13.4% annually over the next 5 years. This means 2016 EPS will come out to $6.44, which, at a 20x multiple, translates to a future stock value of $128.80. Discounting backwards by 10% yields a present value figure of $80. This is at more than a 20% discount to the current market valuation, and I thus recommend selling shares as multiples correct to peer levels.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Costco Wholesale. Motley Fool newsletter services recommend Costco Wholesale. 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.