The retail sector is full of both landmines and hidden treasures. Investors are just as likely to run into a ticking time bomb as they are to find a truly great business trading at an affordable share price. The rise of online shopping giants only deepens the gap between the winners and losers.
To help you separate the wheat from the chaff in today’s retail market, we asked three Motley Fool investors to highlight their best ideas in today’s retail sector. Read on to see why you should give Ulta Beauty (NASDAQ: ULTA), The TJX Companies (NYSE: TJX), and Big Lots (NYSE: BIG) a second look right now.
Demitri Kalogeropoulos (Ulta Beauty): It’s a reflection of the high expectations Wall Street had for the business that Ulta Beauty shares are down sharply in the past year. The retailer’s recently closed fiscal 2017 was impressive by any measure, after all. Revenue rose 21% thanks to a quickly growing store base and an 11% spike in comparable-store sales. Gross profit margin held steady at 36% of sales, too, as adjusted earnings increased by 25% compared to 2016.
Sure, the beauty products retailer is facing a more difficult year ahead. There’s been a growth slowdown in its core makeup industry, which has increased pricing pressure. Ulta is also seeing a profitability pinch thanks to surprisingly strong growth in its e-commerce segment. Management had hoped that division would reach 10% of sales by 2019 — but it shot past 13% last year.
These shifts mean that operating margin won’t inch toward 15% of sales this year as CEO Mary Dillion and her team had forecast in early 2017. Instead, profitability will contract slightly for the second straight year, dipping just below 13% of sales.
Yet Ulta should still be able to boost comps at a market-thumping rate in 2018 as it adds 100 more locations to its base. That growth would translate into another year in which earnings rise by more than 20%. These are figures that most retailers would kill for, and they should contribute to solid long-run returns for investors.
The cold never bothered me anyway
Anders Bylund (Big Lots): Discount retailer Big Lots is on an upswing these days. Top-line sales have plateaued at a comfortably high level, cash profits are on the rebound after a couple of lean years, and that 2.5% dividend yield is a flat-out record.
Yet the stock has plunged 24% lower in 2018, and you can pick up Big Lots shares for prices befitting the company’s low-cost retailing strategy. The stock is trading at just 9.6 times trailing earnings and 7.2 times free cash flow, or 0.4 times annual sales. That’s what happens when a fundamentally strong business runs into market pessimism — discounted shares prices divided by solid profits equals really low valuation ratios.
This silly situation stems from Big Lots’ fourth-quarter report, wherein the company beat the Street’s earnings estimates but fell slightly short of revenue targets. A brutally cold winter kept shoppers from venturing out to their local Big Lots stores, making it difficult to meet weather-agnostic financial targets.
So the stock fell more than 10% in a single day when these results were published, leading to the attractive risk/reward profile you see today. If you see the fourth quarter as a weather-powered anomaly, both the business and the stock are bound to recover from their current doldrums. And if you buy at these low prices, you also lock in that sweet, sweet dividend yield for the long run.
That’s a downright fantastic buying opportunity in my book.
The king of off-price retail
Leo Sun (The TJX Companies): TJX owns off-price retail chains T.J. Maxx, T.K. Maxx, Marshalls, HomeGoods, HomeSense, Winners, and Sierra Trading Post. TJX’s business is often considered “Amazon- proof,” since it buys excess inventories “Amazoned” from retailers at dirt-cheap prices.
TJX uses a global network of over 1,000 buyers to purchase products from more than 20,000 vendors in over 100 countries at steep discounts. That scale gives it the clout to negotiate extremely low prices for products, which it sells back to consumers at lower prices than Amazon.
Its stores, which might seem disorganized at first, are designed to encourage “treasure hunters” to scour through their shelves for hidden gems. This strategy drives shoppers, especially lower-income ones, back to its stores even as more people buy goods online.
TJX is trying to keep shoppers coming with new marketing campaigns, its TJX Rewards loyalty program, and a constantly rotating selection of products. TJX currently runs over 4,000 stores, and it’s expanding its international footprint with new stores in Europe and Australia. The company plans to open hundreds of new stores over the long term.
Wall Street expects TJX’s revenue and earnings to rise 6% and 22% this year, respectively. Those are solid growth rates for a stock that trades at just 17 times forward earnings. TJX also pays a forward dividend yield of 1.5%, and it’s hiked that payout annually for over two decades.