Caution warranted on consumer discretionary stocks

Don't count on consumers to keep spending as much.

By Stock Traders Daily Mar 8, 2012 10:31AM

Fuse/Getty ImagesAs consumers and investors have begun to feel better about the economy and the labor market in particular, one of the hottest sectors in the stock market has been consumer discretionary.

Since the beginning of December, the SPDR Select Consumer Discretionary ETF (XLY) has staged a 12% rally. Consumers and investors alike have been in a much better mood, and this is evident in the consumer confidence reports. In February, the Consumer Confidence indicator jumped to 70.8 from 61.5 in January, which was the strongest reading since February 2011.


So far, it appears as if the market has mostly brushed aside the surge in gas prices. The logic, it goes, is that the improving job market will trump higher prices at the pump. I would argue, however, that this will not be the case. While the reported headline unemployment numbers seem encouraging, moving down to 8.3%, the "real" unemployment number has flat-lined since 2009, and is currently at 10.3%. The real unemployment includes those who have dropped out of the labor force, and therefore, are out of the reported number.


Also, hourly earnings and personal income has not improved -- in fact, these metrics appear to have worsened. Throughout much of 2011, personal income growth hovered between 0.3 to 0.8%. It came in at 0.2% in January. Hourly earnings have been flat to a low 0.2% growth. Before the economic crisis struck, hourly earnings growth was clocking in at 4%. We are nowhere near those levels, and even worse, the trend has continued to weaken.


So, with this in mind, I wanted to take a look at a few consumer discretionary stocks that could be vulnerable to a snap-back should confidence begin to wane.


On the brink
Brinker International
(EAT) is the owner and operator of Chili's Grill and Bar and Maggiano's Little Italy restaurants. Since last fall, the stock has mounted a strong rally, but appears to have run out of steam, chopping around in a $26.50-$28.00 range. EAT has done an admirable job of turning its Chili's operations around, which is evident in its improved recent financials. But it is not a growth story, with revenue up a paltry 1.5% last quarter. And as consumers pay more to fill up their cars, one area where they will likely scale back is dining out. This could provide a headwind to its already fragile topline growth.


GRMN found its groove, but expectations now higher
How many people were expecting a 50% plus surge from Garmin (GRMN), beginning last October? I certainly wasn't. Like most others, I looked at GRMN as a company well past its prime, and buried by smartphone devices that have mapping and direction capabilities. But the company has reported back-to-back blow out quarters, igniting this improbable rally. After suffering through years of average selling price declines, ASPs have finally stabilized. A rebound in the auto sector has also helped its cause. With that said, some of this outperformance relative to consensus estimates is just that the bar had been lowered so far, after consistently falling short of expectations. GRMN's recovery gained momentum much quicker than the Street anticipated. But after a couple of blow-out quarters, analysts are going to ratchet their expectations higher, lessening the odds of another blow-out quarter. Further, its sales growth rates are still very modest, at 8% last quarter. With a price-to-sales ratio of 3.3, GRMN shares are no longer considered "cheap."


SBUX a potential buzzkill
In the summer and fall of 2011, Starbucks (SBUX) was able to successfully offset rising commodity costs by increasing the prices for some of its drinks. With gas prices spiking higher, it is likely that food/dairy prices will also, once again, go higher. Should that happen, SBUX will have to attempt to raise prices again, or it faces the risk of margin compression. On the plus side, SBUX does have decent growth catalysts ahead as it expands internationally, but it is priced for perfection. It currently has a price-to-earnings ratio approaching 30 and a price-to-sales over 3.


Filling in the Gap
Another stock that has made an unlikely run is Gap (GPS), which is trading at its best levels since early 2010. On March 1, the retailer reported better-than-expected same store sales figures, following its Q4 bottom-line beat on February 24. GPS has done a much better job managing inventory, and it says its spring product line has been well received. Fundamentally, the company has made significant strides. However, the stock's parabolic rise over the past few weeks, coupled with the fact that near-term overhead resistance resides at the $24.50 level, make it a candidate for a snap-back.

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