Retail Discount Stores Outlook: Sales Picture Upbeat

Gradual wage acceleration, steady job growth, improving consumer sentiment and sound economic fundamentals are working in tandem for the Retail - Discount Stores Industry. Additionally, the cut in corporate tax rate is allowing retailers to channelize the surplus money toward best possible alternatives. Further, an individual tax cut is freeing up disposable income, forming a firm foundation for higher consumption.

Notably, consumer spending picked up 3.8% during the April-June quarter, per the second estimate released by the Commerce Department. The metric increased 0.4% in July, marking the sixth consecutive month of gains. For obvious reasons, retailers are the beneficiaries, as evident from the 0.5% uptick in July retail sales from June. Moreover, the National Retail Federation's projection of a tick-up in U.S. retail sales of at least 4.5% this year raises optimism.

No wonder a significant number of companies in the industry have been on a tear buoyed by the aforementioned underlying strengths. Such favorable factors shape a rosy near-term outlook for the industry that as such remains quite competitive and fragmented. Companies are always vying to take a bigger slice of the market on attributes such as price, products and speed-to-market.

Certainly, discount retailers have succeeded in creating a niche despite the rising popularity of online retailers that has compelled many traditional operators to make an exit. This has been largely supported by investments, focus on cost savings and introduction of loyalty and marketing programs.

Retailers are deploying resources to enhance omni-channel capacities, introduce brands, remodel or refurbish stores and expand same-day delivery options to expedite the shopping process.

As companies are trying all means to combat competition, costs associated with promotional activities and an aggressive pricing strategy have been eating into margins. Meanwhile, competition from private-label brands, high wage expenses and increased merchandise costs are other bottlenecks. Moreover, concerns related to tariff cannot be disregarded.

Industry Performance Eclipses S&P 500

The Zacks Retail - Discount Stores Industry , within the broader Zacks Retail & Wholesale Sector , has outperformed both the Zacks S&P 500 Composite and its own sector over the past year. While stocks in this industry have collectively gained 46.2%, the Zacks S&P 500 Composite advanced 15.6% and the Zacks Retail & Wholesale Sector rose 27.9%.

Looking at shareholder returns over the past year, it is quite apparent that investors are quite confident about the industry's prospects. The strategy to sell products at heavily discounted prices has helped players in the industry expand their customer base.

Moreover, a differentiated product range enables them to provide an upscale shopping experience, resulting in market share gains and higher sales per square foot. To keep up with the changing retail landscape, such players have been steadily improving their e-commerce capabilities as well. However, concerns related to margins and rising competition from pure e-retailers are a few killjoys.

One-Year Price Performance

Does Valuation Look Compelling?

Owing to the industry's outperformance in the past year, its valuation looks somewhat expensive when compared with the broader market. One might get a good sense of the industry's relative valuation by looking at its price-to-earnings ratio (P/E), which is an appropriate multiple for valuing Retail - Discount Stores stocks because their earnings are effective in gauging performance.

Generally, a stock rallies on an increase in earnings. As forecasts for earnings move higher, rising demand for the stock should drive its price. If the P/E of a stock is rising steadily, it means that investors are pinning hopes on the company's inherent strength.

This ratio essentially measures a stock's current market value relative to its earnings performance. Investors believe that lower the P/E, the higher will be the value of the stock.

The industry currently has a trailing 12-month P/E ratio of 26.5, which is above the median level of 25.1 but below the high level of 28.0. This clearly indicates that there is still room for upside.

The space also looks unattractive when compared to the market at large, as the trailing 12-month P/E ratio for the S&P 500 is 19.9 and the median level is 20.1.

Price-to-Earnings Ratio (TTM)

Solid Earnings Outlook

Robust omni-channel initiatives including technological updates and store remodels, solid brand enhancing efforts with off-price models and innovative customer-friendly approach have been acting as propellants for the industry. These factors are likely to help stocks in the industry generate positive shareholder returns in the near future. However, higher investments in technology advancements and stiff competition play headwinds.

Nevertheless, what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. While the earlier valuation analysis reflects that there is still room for upside, one should look for good entry points based on sound fundamentals and other constructive factors.

One reliable measure that can help investors understand the industry's prospects for a solid price performance is its earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.

The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for the industry and its aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.

Price and Consensus: Zacks Retail - Discount Stores Industry

As you can see here, the $5.44 EPS estimate for 2018 is up from $5.24 at the end of July and $5.04 at the end of January. The current EPS estimate also shows a significant improvement from the year-ago estimate of $4.63. Looking at the aggregate estimate revisions, it appears that sell-side analysts are optimistic about this group's earnings potential.

Zacks Industry Rank Indicates Robust Prospects

The group's Zacks Industry Rank , which is basically the average of the Zacks Rank of all the member stocks, indicates continued outperformance in the near term.

The Zacks Retail - Discount Stores industry currently carries a Zacks Industry Rank #51, which places it in the top 20% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Our proprietary Heat Map shows that the industry's rank has improved sharply over the five-week period.

Retail - Discount Stores Space: Earnings & Revenue Trends

The past earnings trend of the Retail - Discount Stores space reveals that the group has been witnessing an uptrend since 2015.

Retail - Discount Stores EPS

The top-line performance of the Zacks Retail - Discount Stores industry has been showing growth since 2013.

Retail - Discount Stores Revenues

Better pricing, private label offering, effective inventory management, merchandise and operational initiatives should drive sales and margins. These along with a compelling store growth story at convenient locations and focus on demand-driven products lend support.

Bottom Line

However, a deleverage in SG&A rate owing to higher labor expenses, occupancy costs and utilities expenses might impact margins. Moreover, increasing threat from online retailers on parameters such as same-day delivery and pricing might hurt the company's market share. Nevertheless, a rosy economic environment and an insight into the raised retail sales projections give out positive signals for the Retail - Discount Stores industry.

Given the abundant opportunities, the industry's long-term earnings growth rate of 11% looks promising. This also compares favorably with 9.8% of the Zacks S&P 500 Composite.

Though the valuation looks a little pricey at this time, keeping long-term expectations in mind, investors may look for some good entry points in the stocks that will help them make the most of the momentum in the industry.

Here we have picked four stocks from the Retail - Discount Stores industry carrying a Zacks Rank #2 (Buy). You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here .

Burlington Stores, Inc. (BURL): The consensus EPS estimate for this Burlington, NJ-based company - a retailer of branded apparel products - has moved up nearly 3.3% for the current fiscal in the last 30 days. Moreover, this Zacks Rank #2 stock has surged 88% over the past year.

Price and Consensus: BURL

Costco Wholesale Corporation (COST): This Issaquah, WA-based operator of membership warehouses carries a Zacks Rank #2 and has risen 52% in the past year. The Zacks Consensus Estimate for the company's current fiscal EPS has been stable in the last 30 days.

Price and Consensus: COST

Target Corporation (TGT): This Minneapolis, MN-based company carries a Zacks Rank #2 and has rallied 54% in the past year. The Zacks Consensus Estimate for this general merchandise retailer's current fiscal EPS was revised 1.7% upward in the last 30 days.

Price and Consensus: TGT

The TJX Companies, Inc. (TJX): This Framingham, MA-based off-price retailer of apparel and home fashions carries a Zacks Rank #2 and has surged 51% in the past year. The Zacks Consensus Estimate for the company's current fiscal EPS has climbed 1% in the last 30 days.

Price and Consensus: TJX

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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