Retail stock rally is an overreaction caused by low expectations, say experts

Posted by jbrumley on August 24, 2017 4:30 PM

Shares of companies like Abercrombie & Fitch and Signet are up by double digit percentage amounts after earnings beats

By Tonya Garcia, MarketWatch

A wave of retail stocks have rallied more than 10% Thursday, after companies reported second-quarter earnings that exceeded estimates, a move experts deem an overreaction, coming after a number of gloomy quarters and lowered expectations.

“What we’re seeing here is an overreaction from the market,” said Natalie Kotlyar, leader of BDO’s retail and consumer products practice. “When highly-anticipated earnings announcements defy expectations for better or for worse, Wall Street takes the good or bad news and amplifies it. Given that consumer confidence is somewhat shaky and prices are dropping in the housing market, investors are taking miles from inches wherever they can.”

Companies with stocks that are up by double-digit percentage amounts include Abercrombie & Fitch Co., Signet Jewelers Ltd. Perry Ellis International Inc. and Guess Inc.

Other companies whose stocks have jumped nearly 6% include Dollar Tree Inc. and Calvin Klein parent PVH Corp.

One after another, retailers have cited a challenging landscape when reporting their latest earnings. From bankruptcies to store closures, the shift to e-commerce and the impact of Inc. the list of hurdles is long.

Even companies that reported losses, as Abercrombie & Fitch did, are getting a bump. And the good cheer is spreading to other brands and retailers that haven’t reported, like Fossil Group Inc. which is up 11%, and Lands’ End Inc  up 8.4%.

“Rather than being a sign that retailers are now pushing back against Amazon, which some certainly are, I think it more of a sign that retailers are trying to carve out their places in the industry to emerge from earnings unscathed, rather than being branded another victim of the ‘retail apocalypse,” said Kotlyar. “Any small steps toward improvement are warmly welcomed by investors.”

Moreover, according to Charlie O’Shea, vice president and senior credit officer at Moody’s, there’s only so much you can determine based on a single quarter.

“It’s a very brief snapshot, it’s not a movie,” he said. “I’d be hesitant to draw any long-term conclusions from Q2 2017 operating income results. There’s a lot of stress out there with retail and you’re going to have good quarters and bad quarters.”

O’Shea emphasized that the picture for the long term is blurred by variables. In addition to the aforementioned factors, there’s also the back-to-school season, which starts earlier each year, and continued “choppy” consumer behavior.

“This holiday season is going to be really important, and how retailers handle promotions will have an impact on margins,” he said.

In the longer term, Monica Aggarwal, managing director and sector head for consumer and retail at Fitch Ratings, says we’re going to keep seeing “the accelerated rationalization of excess inventory and square footage over the next 12-to-18 months in the space to address the supply demand imbalance, particularly department store and apparel.”

But the sector will continue to differ on a company-by-company basis as well. Winners will have created some sort of moat between themselves and companies excelling at e-commerce, those in the value space, and businesses with cash flow generation and an operating strategy that protects market share, said David Silverman, senior director at Fitch Ratings. This includes dollar stores, home improvement retailers like Home Depot Inc. and off-price apparel, like T.J. Maxx parent TJX Cos. and Burlington Stores Inc.

“We are also more constructive on companies that have wide exposure across a variety of retail channels, including names like Nordstrom (which has a significant presence online and in off-price) and some of the apparel manufacturers,” he said. Examples based on second-quarter results from the past day include Michaels Cos. Inc. and PVH.

“That being said, we continue to believe that many companies in challenged segments, particularly apparel, will continue to struggle,” Silverman said.

The SPDR S&P Retail ETF is down 12% for the year so far while the S&P 500 index is up 9% for the period.

From MarketWatch