3 beaten-down retailers to buy now

The market is acting like it's the end of the world for retail. It's not.

By Traders Reserve May 23, 2014 12:50PM
Pedestrians walk past the Urban Outfitters Inc. store in San Francisco, Calif. (© David Paul Morris/Bloomberg via Getty Images)By Jamie Dlugosch 

 

As retailer after retailer reports disappointing numbers, valuations among retailing stocks have been decimated.

 

And for what reason? Bad weather is the only reason for the poor performance, and yet the market is acting as if it is the end of the world. Trust me, it is not.

 

The Federal Reserve is preparing to raise interest rates -- perhaps earlier than expected -- and it's doing so because the economy is roaring.

 

So don't be fooled by the weather blip -- even though the market is clearly fooled when it comes to retail stocks.

 

Names like Urban Outfitters (URBN), TJX Companies (TJX) and Staples (SPLS) were all hit particularly hard after lackluster earnings reports.

 

What the market should be saying is this: Who cares about the past?

 

What I want to know and what the market should care about is the future. It is true that these same retailers are ratcheting down expectations going forward, but can you blame them? It is the perfect setup. Management knows the market is likely to overreact to the immediate news, so why not lower the bar?

 

Doing so sets the stage for an earnings beat down the road and rapid recovery in share price.

 

That is how I would play the retailers today, buying on any harsh selling to the downside.

 

Take Home Depot (HD), for example. Within its own disastrous report the company noted that sales were humming in the current quarter.

 

That same action is going to be repeated over and over again for many retailers in the coming months. As such, now would be the perfect time to get involved in some of these beaten down retailers.

 

Here are three of my favorites that look great now:

 

American Eagle Outfitters (AEO)

The teen fashion retailer is down more than 23 percent this year, including a 5 percent drubbing on Tuesday. Its disappointing earnings report on Wednesday sent the stock tumbling another 6 percent. The selling has gone too far.

 

Malls are still crowded and the consumer is getting stronger. The back-to-school season promises to be huge and the expectations are about as low as they can get.

 

This is a great contrarian play. Analysts expect profits to be lower in the current fiscal year ending Jan. 31, 2015, but in the following year growth returns to the tune of 30 percent. With the stock trading at 17 times current fiscal year estimated earnings, shares are cheap. I would be a buyer of American Eagle on any weakness.

 

Urban Outfitters (URBN)

The hipster retailer dropped by nearly 10 percent after its disappointing earnings report on Tuesday. That brings the bloodbath tally to 25 percent in a year's time.

 

Now solidly in bear market territory, the time to buy is now. Urban Outfitters is lowering the bar for the current fiscal year, with three quarters to go. That is terribly pessimistic, but perhaps calculated.

 

To the extent retail sales improve as we hit the summer months, the upside surprise potential has increased exponentially. I like my odds here and I would be a buyer of this solid retailer at these severely discounted prices.

 

Gap (GPS)

Surprisingly, Gap is one of the best apparel retailers in the bunch. In April, the company trounced expectations for sales and shares moved higher. That bounce put Gap in positive territory in 2014, one of the few retailers to be able to do that.

 

It has been a long road to this point for Gap and I expect it to continue for the remainder of this year and perhaps beyond. I say "perhaps" as nothing is guaranteed, especially in the fickle apparel retail space.

 

In the short term, the scenario at Gap looks compelling. For starters you have those strong April sales numbers. Analyst expectations for growth are really low at the moment, thus more months like April is going to really surprise the market and keep the stock price on the move higher.

 

Currently the expectation is for double-digit profit growth from the current fiscal year to the next. At current prices, shares trade for 13 times current fiscal year estimated earnings. Look for those estimates to go up as the economy strengthens.

 

More from Traders Reserve


 

3Comments
May 23, 2014 3:28PM
avatar
How can anyone compare the GAP, URBN, and AEO with Home Depot?  Clothes are clothes are clothes.  Home Depot caters to a different clientele and, presumabl  one who has more money to spend.
May 23, 2014 8:36PM
avatar
Home Depot, Lowes, Menards...Lumber is lumber, is lumber.
May 23, 2014 2:18PM
avatar
stay away of retailers there is overcapacity and is a carnage and will get worst
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