Emerging Value in the Retail Sector

In case you hadn’t heard, Amazon is coming to Australia. It’s will open its virtual doors any day now.

This imminent arrival is having a negative impact on the whole retail sector. While the Aussie economy is healthy and employment growth strong, wages growth is lacking. As a result, retail sales growth is weak, and retailers are out of favour.

Investors are worried that Amazon’s price cutting arrival will further damage the sector. And they’re no doubt right. The question is whether the Amazon effect is now in the price.

No one really knows the answer to that. And until Amazon launches and you get a better idea of its impact, there will continue to be more uncertainty than usual around investing in the retail space.

But here’s something to look out for. It happened in US trading on Friday.

That is, a couple of beaten down retail stocks rallied sharply…on bad news. But the bad news wasn’t as bad as the market had expected. So the stock prices shot higher. As the Wall Street Journal reports:

Specialty retailers, including Abercrombie & Fitch Co. and Foot Locker Inc. gave some hope to investors that their businesses were evolving with the times, providing a reprieve after a sluggish start to the year as they warned that changes in shoppers’ habits would hurt profits. 

Shares in Foot Locker had their best day in at least 40 years in Friday trading, while Hibbett Sports Inc. and Abercrombie stock rose 15% and 24%, respectively. The companies all posted same-store sales that were higher than expected, with the price moves highlighting the impact of positive reports from the sector.

Foot Locker in August signaled that growth in the athleisure market may be coming to an end, as it reported its first same-store sales decline since 2009. On Friday, the retailer’s 3.7% decline in comparable-store sales came in ahead of estimates, as analysts polled by Consensus Metrix expected a 4.2% decline.

For Hibbett, analysts expected a drop of 8.4%, but the retailer posted same-store sales that fell 1.3%.

Let’s have a look at the chart of Foot Locker:

Foot Locker chart 20-11-17

Source: Bigcharts

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The stock price was nearly US$80 a share in December 2016, and recently fell to a low of near US$30. That’s a decline of around 60% in 12 months.

But the pessimism was perhaps overdone. Prior to last week’s rally, Foot Locker traded on a price-to-earnings (P/E) multiple of just 8 times expected FY18 earnings. The market average in the US is closer to 20 times!

So when sales growth didn’t fall as badly as expected, it was enough for the selling to end and the buying to kick in.

The rally also occurred on big volume, which is an encouraging sign.

Would you rather buy Foot Locker on a PE of (now) 10 times FY18 earnings, or Amazon on a PE of 136 times?

Although it feels dumb saying it, over the next five years I reckon Foot Locker will provide better investor returns than Amazon. In the last three years Foot Locker has generated over US$500 million in free cashflow per annum.

It has a market value of US$5.3 billion, so that’s a free cashflow yield of around 10%! (Free cashflow means cash generated from operations less cash used for investing activities.) 

What does this mean for Aussie stocks?

While it might be too early to jump in and thumb your nose at the Amazon effect. Keep an eye out for turning points like the above. That is, when you see buying on negative news. It means the news wasn’t as bad as expected. Often this is a turning point.

Let’s take JB Hi Fi [ASX:JBH] as a local example. The stock trades on a PE of about 10.5 times expected earnings for FY18. That’s well below the Aussie market average of around 15.

In other words, JBH is cheap relative to the market. But that’s because its growth prospects are much more uncertain. According to analysts who follow the stock, earnings will be flat for the next three years at least.

Not that anyone knows. But that’s the market’s best guess.

And to give you an idea of where sentiment is right now, JBH is a more popular stock to bet against, rather than buy. As the Financial Review reports:

Phil King of Regal moved the market when he revealed his bet against retailer JB Hi-Fi just as Amazon prepares an Australian assault.

Mr King estimates as much as 60 per cent of JB Hi-Fi’s profits could disappear in the next few years, particularly if Amazon rolls out its Prime subscriber option.

That would be a disaster, which is obviously why the guy is short the stock. But rather than guess what will happen, I’d rather rely on the chart.

And right now, the chart is telling you to stay away. It’s been trending down all year. It looks like it could go lower still.

JB Hi Fi stock chart 20-11-17

Source: Bigcharts

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If the stock price breaks below the June low at around $21.50, chances are you’ll see another decent fall.

But for evidence that the worst is over, watch out for price moves that go against the news. Price rises on bad news are nearly always a good sign. It tells you that everyone who will sell, has sold.

We’re not at that point yet. But as the overall market becomes fully valued, one pocket of emerging value is in the retail space. So it’s worth keeping an eye on.

Regards,

Greg Canavan,
Editor, Crisis & Opportunity


Greg Canavan is a Feature Editor at Money Morning and Head of Research at Port Phillip Publishing.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors.

And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand.

When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases.

Greg puts this philosophy into action as the Editor of Crisis & Opportunity. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis.

Read correctly, a chart contains all the information you need. It contains no opinions or emotion. Combine that with traditional stock analysis and you have a robust stock-selection strategy.

With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the basic, costly mistakes that most private investors do every time they buy a stock.

To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Money Morning here.

And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here.

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