Updated on June 7th, 2019 by Nate Parsh
Physical retailers have had a very difficult time in recent years. The retail industry is being disrupted at a rapid pace as consumers continue to shift their buying preferences online.
Shopping malls are losing a great deal of customer traffic to e-commerce retailers like Amazon.com (AMZN) and others. Internet retailers often have the same merchandise as physical stores, but often at a lower price. Online shopping also affords consumers the convenience of shopping at home.
More than 5,500 stores closed in 2018 and more than 7,000 stores are expected to close in the current year. This has taken a steep toll on share prices of brick-and-mortar retailers, particularly those that rely on shopping malls.
Walmart (WMT) and Target (TGT) have arguably fared the best at investing in e-commerce and successfully fending off Amazon. Both Walmart and Target are members of the Dividend Aristocrats, an exclusive group of 57 stocks in the S&P 500 Index with 25+ years of consecutive dividend increases.
The requirements to be a Dividend Aristocrat are:
- Be in the S&P 500
- Have 25+ consecutive years of dividend increases
- Meet certain minimum size & liquidity requirements
You can download an Excel spreadsheet of all 57 (with metrics that matter) by clicking the link below:
Although Amazon can appear unstoppable, retail stores haven’t given up. Many of them are beginning to invest in e-commerce and direct-to-consumer sales. It may take some time for these stores to regain the ground they have lost to online shopping companies, but that doesn’t mean that investors should avoid the retail space altogether.
More information can be found in the Sure Analysis Research Database, which ranks stocks based on their total expected returns over the next five years.
This article will look at 7 undervalued retail stocks with the highest five-year expected returns in the Sure Analysis Research Database.
Table Of Contents
- The Gap, Inc. (GPS)
- L Brands (LB)
- Kohl’s Corporation (KSS)
- Nordstrom Inc. (JWN)
- Foot Locker Inc. (FL)
- Macy’s (M)
- Bed, Bath & Beyond (BBBY)
Top Retail Stock #7: The Gap, Inc. (GPS)
The Gap Inc. is a U.S. clothing and accessories retailer based in the U.S., though the company does have operations around the world. The company operates 6 business divisions: Gap, Banana Republic, Old Navy, Intermix, Hill City and Athleta. The Gap was founded in 1982 and has a market cap of $6.8 billion, with annual revenues of nearly $17 billion.
On 2/28/2019, The Gap announced that it was planning to spin off its Old Navy division into a standalone company.
Source: Investor Presentation
Old Navy contributes ~47% to annual sales. This spinoff should help better position the two new companies and allow The Gap to focus on improving its other businesses.
The Gap reported first quarter of fiscal 2019 financial results on 6/3/2019. The company earned $0.24 per share, dropping 43% and coming in $0.08 below estimates. Revenue was down 2% to $3.7 billion, $71 million below expectations.
Comparable-sales were down 4%. Old Navy comparable-sales were down 1% after improving 3% in the first quarter of 2018. Banana Republic declined 35 while the Gap brand suffered a 10% decrease in sales.
Gross margins fell 140 bps to 36.3% primarily due to lower merchandise margin. The company did buy back almost 2 million shares for a total of $50 million. The Gap expects to repurchase approximately $50 million worth of shares in each quarter of fiscal 2019.
The Gap announced that it expects to close 230 Gap specialty stores over the next two years. The cost of these store closures is expected to be $250 million to $300 million. This will subtract $625 million from annual revenues, but provide $90 million in annualized pretax savings.
The Gap opened a net 43 new stores in the quarter. The company also acquired 140 stores from Gymboree. The company ended the quarter with almost 3,900 stores in 43 countries.
After weak first quarter earnings, The Gap reduced its full year guidance for earnings-per-share to $2.04 to $2.14 from $2.11 to $2.26 previously.
The Gap has grown earnings-per-share at a rate of 5% over the last decade, but that figure is somewhat deceiving. As with other companies on this list, this growth rate is mostly due to share repurchases. Over the last 10 years, The Gap has seen its share count lowered by an average of 5.7% per year.
This has masked the fact that the company’s operating margins have faced enormous pressure. From 2009 to 2014, annual operating margins fell in a range of 9.9% to 13.4%. Since then, operating margins have ranged from 7.7% to 9.6%. The impending reduction in store count will also weigh on profitability.
We expect an earnings growth rate of just 1.8% per year over the next five years due to margin pressures from store closures and share repurchases.
The Gap maintained the same dividend from 2015 through 2017, before increasing its by 5.4% in 2018. The company has an expected dividend payout ratio of 39% for the current fiscal year. Shares yield 5.4%.
Based off of the 6/6/2019 closing price of $18 and earnings estimates for the current fiscal year, shares of The Gap trade with a price-to-earnings multiple of 8.6. Due to the likely impact from store closures on margins over the next two years, we have assigned a target price-to-earnings ratio of 11, below the stock’s average valuation of 12.7x earnings. If shares were to reach this target by 2024, then valuation would add 5% to total annual returns during this time period.
The Gap’s total annual returns will consist of the following:
• 1.8% earnings-per-share growth.
• 5.4% dividend yield.
• 5% multiple expansion.
We find that The Gap is likely to offer a total annual return of 12.2% over the half decade. While this would normally qualify the stock as a buy, we feel that the expected earnings growth rate and multiple expansion are below most of the other names on this list. We feel that there are better opportunities in the retail space than The Gap at the moment. We rate shares of The Gap as a hold.
Top Retail Stock #6: L Brands, Inc. (LB)
L Brands began as The Limited, which opened its first store in Columbus, Ohio in 1963. The company went public in 1969 and by 1976, The Limited had more than 100 stores. The company purchased Victoria’s Secret for $1 million.
Today, L Brands is a specialty retailer with a variety of brands, including Victoria’s Secret, PINK and Bath & Body Works. L Brands operates more than 2,920 company-owned specialty stores and more than 650 franchised locations around the world. The company trades with a market capitalization of $6.3 billion, with annual revenues of $13 billion.
It has been a different story for the two main segments of L Brands.
Source: Investor Handout
While Victoria’s Secret sales have declined 9.4% from 2014 through 2018, Bath & Body Works has grown more than 15%. A decline in mall traffic has been responsible for the drop in sales for Victoria’s Secret.
In an effort to revitalize the Victoria’s Secret brand, the company has brought in new management and invested in direct-to-consumer and digital sales. These investments are beginning to pay off as L Brands believes that its direct-to-consumer business can grow at a mid-teens level and generate $2.5 billion in annual sales.
L Brands reported financial results for the first quarter of fiscal 2019 on 5/22/2019. The company earned $0.14, which was a 17.6% decline from the previous year. L Brands had been expected to break even for the quarter. Revenue inched up 0.1% to $2.6 billion, which was $68 million higher than expected.
Bath & Body works again produced a solid growth rate, with comparable-sales increasing 13% during the quarter. Comparable-sales declined 5% for Victoria’s Secret. While sales were down for this segment it appears that the declines have stabilized somewhat from previous quarters.
Gross margins for L Brands decreased 40 bps to 35.5% due to a decline in merchandise margin rate. Lower market expense improved SG&A expenses by 30 bps. Share-based compensation was responsible for a tax rate of 33.6% versus the company’s estimated statutory rate of 27%. This had been expected, but nonetheless weighed on results.
L Brands revised its guidance and now expects to earn $2.30 to $2.60 per share in fiscal 2019 up from $2.20 to $2.60 previously. The mid-point of this update guidance represents a 13% decrease from fiscal 2018. We estimate that L Brands can grow its earnings-per-share at a rate of 3% per year through 2024 due to continued strength in Bath & Body Works and e-commerce offset by slight declines in Victoria’s Secret.
Dividend increases have been slightly sporadic for L Brands over the last decade. For the 3/8/2019 payment, the company made the decision to reduce its dividend by 50%. The dividend was cut so that the company could lower its debt load. The new annualized dividend of $1.20 would consume just 49% of expected profits for the year. We view this as a prudent move and note that shares still offer a 5.3% dividend yield.
L Brands’ stock closed at $23 on 6/6/2019. Using updated guidance for the fiscal year, the stock has a price-to-earnings ratio of 9.4, which compares quite favorably to our expected multiple of 13x earnings by 2024. If the stock can trade at this price-to-earnings ratio by 2024, then investors would see an additional 6.7% added to annual returns over this period of time.
Total annual returns would consist of:
• 3% earnings-per-share growth.
• 5.3% dividend yield.
• 6.7% multiple expansion.
L Brands is forecasted to offer a total annual return of 15% through 2024. Bath & Body Works remains the engine of growth for the company. While Victoria’s Secret continues to under perform, the declines have at least slowed from prior quarters. Improvements in e-commerce are also starting to be realized. Still, this is one of the lower expected total returns on this list. Investors might find more reward by choosing a different retailer. We rate shares as a hold for now.
Top Retail Stock #5: Kohl’s Corporation (KSS)
Kohl’s began as a single department store in 1962. Today, the company is a leader in the retail industry. Kohl’s product offerings include, men’s, women’s and children’s apparel as well as housewares, footwear and accessories. The company operates more than 1,100 stores in 49 states. Kohl’s trades with a market capitalization of $7.8 billion, with annual revenues of $19 billion.
Kohl’s first quarter results, which were announced on 5/21/2019, showed that the company continues to see some softness in its business. Earnings-per-share totaled $0.61, which missed the market’s expectations by $0.06 and represented a 4.7% drop from the prior year’s first quarter. Revenue was down 3.3% to $3.8 billion, which was $123 million lower than the consensus estimates.
Comparable-store sales were down 3.4%, much worse than the expected 0.1% decline. Gross margins were down 10 bps to 36.8%, but SG&A expenses increased 130 bps to 31.2% of revenue. A 5 million share count reduction added $0.07 to earnings-per-share for the quarter.
The company stated they had made mistakes in assessing its appropriate merchandise levels and were moving to correct the issue for the second half of 2019. This likely means that Kohl’s second quarter will show declines as well.
The company has taken initiates to drive traffic to its stores and improve customer loyalty.
Source: Analyst Meet and Greet 2018
Time will tell if partnerships and investments in e-commerce will help improve results.
Kohl’s reduced its guidance for earnings-per-share to $5.15 to $5.45 from $5.80 to $6.15 previously. The midpoint of this guidance represents a 5.4% decline from the previous year.
The company compounded earnings at a rate of 5.7% from 2009 through 2018. Kohl’s has also reduced its share count by nearly 6% during this time. On a dollar basis, Kohl’s was actually more profitable in 2009 than in 2018. We have an expected growth rate of 4% through 2024 due to slow down in share repurchases and pressured margins.
Kohl’s has increased its dividend for the past nine years, leaving the company one year short of becoming a Dividend Achiever . The stock has a current yield of 5.6%.
Kohl’s trades for $48 as of the last trading session. Using expected earnings-per-share for 2019, the price-to-earnings ratio is 9.1. We have a targeted price-to-earnings ratio of 12, which is slightly below the 10-year average of 13. This target accounts for a reduced near-term profitability assumption. If the stock trades at our target by 2024, valuation would add 5.7% to annual returns through 2024.
Total returns would be as follows:
- 4% earnings-per-share growth.
- 5.6% dividend yield.
- 5.7% multiple expansion.
Kohl’s is expected to return 15.3% annually through 2024.
Top Retail Stock #4: Nordstrom, Inc. (JWN)
Nordstrom Inc. sells clothes, shoes and accessories. Some of the chain’s stores also offer home furnishing and wedding products. The company was founded in 1901 and is currently valued at $4.8 billion. Nordstrom is expected to produce nearly $16 billion in revenue this year.
The company released first quarter financial results on 5/21/2019. Results were underwhelming.
Source: Investor Presentation
Nordstrom generated earnings-per-share of $0.23 during the quarter, $0.21 below estimates and a 55% decrease from the previous year. Revenue was down 3.3%to $3.4 billion. This was $120 million less than analysts had expected.
Comparable-sales were down 3.5% versus an expected drop of 0.1%. Gross margins were down 60 bps to 33.5% as Nordstrom aggressively marked down products in order to realign its inventory. Full-price items were down more than 5% while off-price products suffered a slight decline.
On a positive note, the company decreased its inventory by 5.3% and SG&A expenses improved 168 bps year-over-year. Digital sales improved 7% and now account for 31% of total sales, which was a 2% improvement.
Nordstrom bought back $186 million worth of shares in the quarter and has $707 million remaining on its current authorization. This represents ~15% of the current float. The company is also on track to deliver $150 to $200 million in planned annual cost savings going forward. This should help improve margins going forward.
Nordstrom did lower its guidance for the current year and now expects to earn $3.25 to $3.65 per share. The company had previously expected to earn $3.65 to $3.90 per share. The midpoint of the updated guidance represents a 5.5% improvement from last year.
Following first quarter results, we estimate that the company can offer 4% earnings growth over the next five years. This is slightly below the 10-year average growth rate of 5.4%. We feel that a combination of digital sales growth and share repurchases should help the company reach this expected growth rate.
Nordstrom has marinated the same dividend of $1.48 per share since 2015. We expect that this will continue to be the case until a higher growth rate is sustained. That doesn’t mean income investors should ignore the stock. Shares currently yield 4.8%, which compares quite favorably to the stock’s decade long average yield of 2.4%.
We don’t believe the dividend is at risk of being cut as the expected payout ratio, even after the reduction in guidance, is just 43% for the year. This is in-line with the five-year payout ratio of 45%.
Nordstrom’s shares are trading at $31. Using the updated guidance, the stock trades with a price-to-earnings ratio of 9. Our five-year valuation target if 14x earnings. If the stock trades at this target, then valuation will add 9.2% to total annual returns over this time period.
Therefore, total annual returns will consist of:
• 4% earnings-per-share growth.
• 4.8% dividend yield.
• 9.2% multiple expansion.
Shares of Nordstrom are expected to offer a total annual return of 18% through 2024. While the company’s first quarter results were weak, it did see off-price sales decline only slightly and expenses improve. We think that the company’s dividend, though not growing, is safe. It is also well above its average yield 2.4% over the last decade.
Nordstrom receives a buy recommendation from Sure Dividend at this time. Income investors looking for a turnaround play in the retail sector are encouraged to consider buying the stock at the current price.
Top Retail Stock #3: Foot Locker, Inc. (FL)
Foot Locker was originally part of the now defunct FW Woolworth Company. It became an independent company in 1988 and today the athletic apparel retailer operates more than 3,200 stores in more than 25 countries around the world. Foot Locker has a market capitalization of $4.6 billion and produces nearly $8 billion in annual sales.
The company has performed well over the past few years, even as Amazon and other online competitors have become more popular among consumers.
Source: Investor Presentation
Foot Locker reported first quarter financial results on 5/24/2019. The company earned $1.53 per share, which was a 5.5% improvement from the previous year, but missed estimates by $0.07. Revenue grew 2.6% to $2.1 billion, but missed estimates by $28 million.
Excluding the effect of foreign exchange rates, total sales grew 4.7%. Comparable same store sales grew 4.6% while Gross margins improved 30 bps to 33.2%.
Foot Locker has made strategic investments in its e-commerce business, which helps explains why SG&A expenses grew 100 bps to 20%. But this increase in costs has proven worthwhile. While the company’s brick-and-mortar stores saw sales grow just 2.9%, Foot Locker’s direct-to-consumer channel increased nearly 15%. Direct-to-consumer sales accounted for 15.4% of total sales, up from 13.9% from all of 2018.
Despite this, the miss on the top and bottom line caused the stock to decline 16% in the trading session following the results release. Shares are down another 7% or so from the day of the results release. Perhaps this significant decline has afforded investors an opportunity to purchase Foot Locker shares at an attractive price.
We expect that Foot Locker will earn $5.10 per share in 2019, which would be an 8% increase from 2018. From 2009 through 2018, Foot Locker experienced a nearly 25% annual increase in earnings-per-share. Some of this growth is due to an improvement in net profit margin and a 10% per-year reduction in share count.
We forecast that the company can compound earnings-per-share at a rate of 6% annually through 2024 due to gains in e-commerce and a contribution from improving same-store sales.
Foot Locker has increased its dividend for the past nine years, leaving it one-year shy of reaching Dividend Achiever status. The company increased its dividend by 10.1% for the 5/3/2019 payment. This raise was slightly above the 10-year compounded growth rate of 8.7%. Shares yield 3.7% at the moment. This is one of the lowest yields on this list, but still well above the ~2.0% average yield for the S&P 500.
Shares of Foot Locker trade for $41. Using the expected earnings-per-share guidance for the year, the stock has a multiple of 8. We have a 2024 target multiple of 13x earnings, which is just below the 10-year average multiple of 14x earnings. If shares were to reach our target by 2024, then valuation would add 10.2% to annual returns over this time period.
Total annual returns would consist of the following:
• 6% earnings-per-share growth
• 3.7% dividend yield
• 10.2% multiple expansion
Added up, we see shares of Foot Locker returning 19.9% annually over the next five years. The company saw gains on both its top and bottom lines during the last quarter, not something every company on this list can say. Due to a combination of growth, yield and multiple expansion, we rate Foot Locker as a buy today.
Top Retail Stock #2: Macy’s (M)
Founded in 1929 and headquartered in Cincinnati Ohio, Macy’s operates 680 department stores and 190 specialty stores. Most stores are found in the U.S. The company has a current market capitalization of $6.3 billion and generates $25 billion in annual sales.
In an effort to compete more with e-commerce companies, Macy’s has invested in its digital offerings.
Source: First Quarter Presentation
Macy’s has really expanded its online presence since early 2018. The company has added new brands and categories to its portfolio. It also has seen growth in its Vendor Direct program. Approximately 10% of online sales now come from Vendor Direct. Macy’s expect to add at least 1,000 vendors to this program this year. Mobile sales were the company’s fastest growing sales channel in 2018, adding more than $1 billion in sales last year.
Macy’s reported first quarter financial results on 5/15/2019. The company earned $0.44 per share, which was $0.10 above estimates, but a decline of 8.3% from the first quarter of 2018. Revenues were down 0.7% to $5.5 billion. This was $20 million below estimates.
Comparable sales grew 0.6% on an owned basis versus 0.3% estimates. Note that the company reports comparable sales figures with the distinction between company owned departments and departments licensed to 3rd parties. Including licensed departments, same-store sales were up 0.7% against an expectation of -0.1%. Gross margins declined 80 bps from the prior year, but were in-line with what analysts had been anticipating. Earnings-per-share results for the first quarter included a $0.10 gain from asset sales. The company also announced a $100 million cost savings program in the fourth quarter of 2018.
Macy’s expects to earn $3.15 per share in 2019, which would be a 25% decrease from 2018. The company has compounded earnings-per-share at an 11.5% rate over the past decade.
Earnings peaked in 2014 and have been declining steadily ever since. The company has yet to make a new earnings-per-share high despite a 2.1% annual decrease in share count during this time. We anticipate a 2.8% EPS growth rate through 2024 due to gains in online sales, cost savings and share reduction.
Macy’s has paused its dividend several times over the last decade, mostly recently in 2018. This is likely a prudent move given the troubles in the business. Shares yield 7.4%, one of the highest yields on this list. Still, the dividend appears safe as the company should only pay out just 48% of expected profits for 2019.
Shares of Macy’s trade hands for $20.50 at the moment. Based off of expected earnings-per-share for fiscal 2019, the stock has a price-to-earnings ratio of 6.5. The stock has traded with a 10-year average multiple of 10.5x earnings. If the stock were to trade at our targeted multiple by 2024 then valuation would add 10% to annual returns through 2024.
Total returns would be as follows:
- 2.8% earnings-per-share growth.
- 7.4% dividend yield.
- 10% multiple expansion.
Macy’s is expected to return 20.2% per year for the next five years. The stock trades with a very low valuation and offers a high dividend yield. Investors looking for a deep value stock in the retail space should consider buying Macy’s due to its very low valuation and high dividend yield, with the acknowledgment that Macy’s is not likely to generate high earnings growth going forward.
Top Retail Stock #1: Bed, Bath & Beyond (BBBY)
Bed Bath & Beyond is an omnichannel retailer selling a wide assortment of domestic merchandise and home furnishings. The company operates under the namesake Bed Bath & Beyond store, along with other stores like Christmas Tree Shops, Harmon, buybuy BABY and World Market. The company has a market capitalization of $1.6 billion, with annual revenues of $12 billion.
Bed Bath & Beyond released fourth quarter of fiscal 2018 results on 4/10/2019.
Source: Investor Presentation
The company’s produced adjusted earnings-per-share of $1.20 per share in the quarter, beating estimates by $0.10, but declining 19% from the prior year’s fourth quarter. Revenue dropped 11% to $3.3 billion.
Results were negatively impacted by one less week during the quarter. This accounted for much of the year-over-year revenue decline.
Comparable sales fell 1.4% in the fourth quarter, which was slightly worse than an expected drop of 1.3%. Bed Bath & Beyond has invested heavily in e-commerce recently and it is starting to pay off. Digital sales were a bright spot for the company, helping to offset declines in physical store locations. The company reduced its inventory by 5% during the quarter.
For fiscal 2018, the company earned $2.12, which was 34% lower than fiscal 2017’s results. Revenue dropped 2.6% to $12 billion. Bed Bath & Beyond expected to earn between $2.11 and $2.20 in fiscal 2019.
Even with a nearly 50% reduction in the number of shares outstanding over the last decade, Bed Bath & Beyond’s earnings-per-share in fiscal 2018 is actually 11% lower than it was in fiscal 2009. The company spent $6.9 billion on share buybacks from 2012 to 2016, more than quadruple the current market cap.
We feel that shares are near their trough and investments in online shopping will begin to pay off. Combined with share repurchases, we expect earnings to grow at 4% annually through 2024.
Bed Bath & Beyond has only paid a dividend since 2016. Dividends-per-share increased:
• By 53% in 2017.
• By 8.6% in 2018.
• By an expected 6.3% in 2019.
Using the company’s guidance, the dividend payout ratio should be 31% in 2019. The stock yields 5.4% today.
Using the recent closing price of $12.50 and the company’s midpoint for earnings-per-share guidance for fiscal 2019, the stock has a price-to-earnings ratio of 5.8. Our target price-to-earnings ratio is 10. Reaching this target by 2024 would mean that valuation could add 11.5% to annual returns over this period of time.
Total annual returns will be as follows:
• 4% earnings-per-share growth.
• 5.4% dividend yield.
• 11.5% multiple expansion.
Bed Bath & Beyond could offer a total annual return of 20.9% through 2024. This is due largely to the very low stock valuation. The company struggled in the last fiscal year and the share price has reflected that as the stock is down nearly 10% year-to-date and 35% over the last year.
However, if Bed Bath & Beyond is able to produce results in-line with its guidance, the stock could be very undervalued, especially against our future valuation target. That said, the company has an abysmal history of growing earnings over the last decade.
Even with our highest estimated total annual returns, we encourage only investors with a higher tolerance for risk to consider buying shares of the company.
The retail sector remains in a state of flux as online shoppers have forced the titans of brick and mortar to rethink their business. Every company on this list offers at least 12% total annual returns over the next five years, but comes with some risk. Each company operates a very large network of physical stores.
Most companies on this list have only begun to invest in e-commerce. Those that do so successfully could reward investors with high total returns.