The world of retail is a finicky one where consumers’ perception of merchandise assortments can make or break a retailer’s numbers in any given year. Consumer tastes are always changing, making it difficult for corporate buyers to anticipate which fashions will captivate shoppers’ interests when they make purchase orders for goods months before they hit store shelves. Some buyers are simply better than peers at identifying merchandise people will want. This can create clear winners and losers among companies with identical objectives.
Although investors aren’t normally privy to precise details about upcoming collections, most management teams are forthcoming with their general merchandise strategies, particularly those that work for retailers that have fallen out of favor with consumers. In this turbulent economy, many retailers have been adopting strategies focused on appealing value propositions. For most Americans, the days of splurging at the mall are long gone. Now, a “new normal” has emerged where the masses look for quality brand name merchandise at affordable prices.
A number of retailers continue to look to celebrity endorsements and lucrative private-label lines to increase diversification and prop up margins. Sometimes these bets (or the merchandise selection in general for that matter) don’t strike a chord with consumers, and retailers are forced to clear merchandise via increased discounts and promotions at the expense of the bottom line. Thus, it is important to monitor how much clearance activity has taken place recently.
Often times, even desirable merchandise and a solid strategy aren’t enough to overcome a challenging environment. Astute retail investors consider the buying power of a retailer’s clientele, and how current and future macroeconomic factors, such as home prices, the unemployment rate, the savings rate, payrolls, indebtedness, and recent stock market performance play into where and when people choose to spend their hard earned disposable income. Also, if a retailer's store count is concentrated in a specific region, investors should consider the economy of said region when conducting analysis.
For this screen we have chosen to focus on a commonly referenced “value ratio”, low price to sales, to identify retailers that are trading on the cheap. Companies with high price-to-sales ratios often reflect unjustifiable investor enthusiasm and have routinely underperformed the broader market over long time periods, whereas the opposite is generally true for those with low-price-to-sales ratios. We screened the Retail Soft Lines, Retail Hard Lines, and Retail Store Industries and came up with a list of 90 names. We only considered those with price-to-sales ratios in the 15th percentile and below. Two companies that we believe may interest bargain hunters include Zale Corp. (ZLC) and Big 5 Sporting Goods (BGFV).
Zales is the leading retailer of fine jewelry in the United States. At its latest fiscal year end, July 31, 2011, it operated 1,163 jewelry stores and 666 kiosks located mainly in shopping malls throughout the U. S. and Canada. The company commands approximately 3% of the highly fragmented U.S. and Canadian jewelry market. Zales caters to “value-oriented” consumers and competes with the likes of Wal-Mart (WMT - Free Wal-Mart Stock Report), J.C. Penny (JCP), TV retailer QVC, and others. It has five brands: Zales Jewelers, Zales Outlet, Gordon's Jewelers, and Canadian outfits Peoples Jewelers and Mappins Jewelers.
Currently, Zales’ price-to-sales ratio of .06 is the lowest of any retailer covered by Value Line. We attribute this mostly to its high debt level and business of supplying discretionary wares to middle income consumers. The company’s recent results suggest it is making progress in its turnaround efforts, though. Same-store sales for the January period grew 5.8% (6.1% in constant currency terms) on top of a 7.9% rise in the prior-year period. A 10% increase in units sold offset a 3% decline in average price per unit. The company has been able to successfully pass off higher costs of precious metals and diamonds onto consumers via price hikes. Still, the lower price point bead business became a bigger part of the product mix. Areas of particular strength include the wedding category, colored stones, and charm bracelets. These trends continued to benefit sales on days leading up to and including Valentine's Day, which is reflected in an impressive comp of 8% through February 22nd when the company reported January quarter earnings.
We credit a number of initiatives for the recent improvement. For one, Zales is getting the word out about its revamped assortment by spending more on marketing. Fashion icon Vera Wang has endorsed a line which is doing well. However, a Jessica Simpson line was recently discontinued but should have minimal impact on results. ZLC is also introducing new financing options to those who don’t qualify for its traditional offerings. The company has also exhibited discipline in its promotional activity. We expect these initiatives to continue helping Zales regain profitability. Therefore, this stock's recovery potential is wide. We note, however, these shares are not for the faint of heart, as they routinely have lumpy earnings and receive low scores for Stock Price Stability and Safety.
Big 5 Sporting Goods
Big 5 is a traditional sporting goods retailer with an average store size of 11,000 square feet, or one fifth that of competing “big box” outfits. Its product mix includes athletic shoes; apparel; accessories; equipment for team sports, fitness, camping, hunting, fishing, tennis, golf, snowboarding, and roller sports. It carries well-known brand name manufacturers, including adidas, Coleman, Easton, New Balance, Nike (NKE), Reebok, Spalding, Under Armour (UA) and Wilson. The company’s private label merchandise accounts for approximately 3% of total sales. It currently has 406 stores in operation with a heavy concentration on the Pacific Coast (over 50% in the state of California alone).
It’s not difficult to explain why Big 5 currently has a low price-to-sales ratio of 0.19; recent earnings have fallen victim to warmer-than-normal weather conditions across much of the continental United States. Indeed, the unusually high temperatures have dissuaded many shoppers from coming in and buying relatively high-margined winter gear for general use, snowboarding, and skiing. Same-store sales decreased 2.1% in the fourth quarter of 2011, reversing from a positive single-digit advance in the first half of the quarter to a mid-single-digit decline during second. Traffic fell markedly while the average ticket increased in the low-single-digit range. Merchandise margins were down 190 basis points, reflecting product cost inflation and increased promotional activity.
Weakness likely continued in the March quarter, but there are a number of trends and initiatives in place that may ensure that the current period marks the bottom. Similar to BGFV’s competitors, Dick’s Sporting Goods (DKS) and Hibbett Sports (HIBB), categories outside of winter apparel and equipment have done well. They include running shoes, exercise, and general apparel. The company is also adjusting its assortment to cater to individuals with above-average discretionary spending capabilities. In general, it is reducing its exposure to merchandise with sales that are influenced by weather patterns. It is also fleshing out its website so customers can better view merchandise before coming in to buy. Although we view the risk-and-reward scenario favorably, there is a strong likelihood that these initiatives will not take hold for a while yet. Therefore, only patient risk-tolerant investors should consider this small market cap stock.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.