TJX - XRT: How To Invest In Retail As Retailers Report Results

2023-08-17 09:51:18 ET

Summary

• Retail data in the U.S. is exceeding expectations, boosting the economy despite inflation and global economic challenges.
• The current landscape, however, isn't benefitting all retailers equally.
• Major retailers have had mixed performance in Q2, with some facing continued challenges in bigger ticket items, as well as newfound backlash against social stances.
• Discounters and retailers with a balance between discretionary and consumable offerings appear best positioned to outperform in the months ahead.
• As an investment, I am more bullish on selective retail stocks rather than their industry-specific ETF alternatives.

Retail data is coming in ahead of expectations, bolstering the U.S. economy at a time when many would understandably expect it to be slowing. Sure, inflation is declining. But it’s still higher than desired. The labor market remains strong. Wages are growing, too. Yet growth is more-so on a nominal basis.

These dynamics create certain winners. Winners that may not have an adequate level of representation in certain baskets, such as the SPDR® S&P Retail ETF ( XRT ).

For investors seeking positioning in the retail sector, I view discounters and those with a healthy balance between discretionary and consumable offerings as best positioned to outperform in the current market environment.

Current State Of Retail In The U.S. Economy

The retail environment remains on solid footing, despite increased global economic challenges. The Commerce Department’s monthly retail report for July, for example, showed sales up a seasonally adjusted 0.7%, up from June’s 0.3% gain and well above the 0.4% consensus. This was also the strongest rate of growth since the start of the year.

July’s spending data, which outpaced the 0.2% inflation reading, was broad-based, with increases in categories such as bars/restaurants and groceries, as well as in clothing and books. The latter was likely attributable to the back-to-school categories.

The higher overall spending came on the heels of a series of strong data on consumer confidence . In July, the index rose to its highest level in two years. Lower inflation and a still-strong labor market are two factors for this. One can also point to improved perceptions as another factor. Those expecting to be better off financially a year from now, for instance, is at the highest level since September 2021, according to The New York Fed’s Survey of Expectations for July.

Despite the improved outlook, some categories still face uncertainty. Bigger ticket items, especially. In July, sales declined at auto dealerships and at electronics and furniture stores. This was perhaps attributable to the cumulative effect of higher borrowing costs. These categories, after all, are more likely to be purchased on credit.

And while spending increased at hardware stores, it did little to change the outlook for major retailers, such as The Home Depot ( HD ), who on Tuesday reaffirmed their forecast that revenues would decline for the first time since 2009.

How Did Major Retailers Perform In Q2?

It was a mixed bag for those that have reported thus far. HD kicked off a busy week with a double beat on revenues and EPS. More importantly, they also reported better than expected results on comparable sales and authorized a new +$15B share repurchase program.

Despite the positive showing, HD reaffirmed their previously stated guidance, due in part to continued softness in larger-ticket categories.

Target ( TGT ) and The TJX Companies ( TJX ) were the headliners on Wednesday. And the dichotomy between the two reports really shined a light into the current retail environment. At the same time that TGT was reporting a 5.4% comparable sales decline, TJX was boasting about growth in the other direction of 6%.

TGT also said that it expected sales to decline again in Q3 and paired this with another downward revision in profit expectations. Shares, nevertheless, rallied following results on earnings that were better than feared.

And on Thursday, Walmart ( WMT ) continued its winning streak with better than expected results, including U.S. comparable sales growth that flew past consensus estimates. Perhaps to little surprise, food remained a strength. CEO, Doug McMillon, did, however, express encouragement in the sales of their general merchandise.

Common Themes Among Retailers In Q2

Off-price continues to retain a coveted share in the consumer wallet . At Target, sales of apparel and home goods decreased in Q2 as store traffic declined for the first time following 12 consecutive quarters of prior growth. In contrast, TJX reported positive customer traffic, as well as 6% comparable sales growth.

Backlash against social stances was one aspect of TGT’s underperformance. Like Anheuser-Busch InBev ( BUD ), who found themselves stumbling over their politically-divisive marketing campaign, TGT also faced criticism for similar reasons. In their case, prominent displays of Pride-related merchandise turned away those consumers at odds with the display. The subsequent response then alienated those on the other side of the spectrum. The lose-lose ultimately proved ill-fated for TGT’s results.

Consumers are also still saying no to big-ticket discretionary purchases . A magic number that was put out by HD’s Executive Vice President, Billy Bastek, was $1,000. In their conference call, Bastek noted that transactions over this benchmark were down 5.5% compared to the second quarter last year. Some of this could be attributable to the pull-forward effect from prior years. Higher financing costs could also be part of the equation.

Is The S&P Retail ETF A Good Investment?

Among the top ten holdings in the XRT are stocks such as Carvana ( CVNA ), American Eagle ( AEO ), and Boot Barn ( BOOT ). These aren’t necessarily the type of stocks suited for the current market environment. Yes, a stock like CVNA, which is sitting on stratospheric YTD gains, may be doing well for the ETF. Yet despite the gains, CVNA is still down 30% over the past year.

This partly explains the flatness seen in the ETF over the past year. Since March 2022, for example, the ETF has traded between $55/share and $75/share.

XRT does include some quality retailers that are performing well in the current environment as part of its holdings. Some names include TJX, Ollie’s, and Dollar Tree, to name a few. But these all carry lower weights in the basket. For XRT to outperform, the representation of these selective stocks in the top ten will likely need to increase.

Are Retail Stocks A Good Investment?

The current landscape is a continued tale of two retailers. On one side of the token are those with a stock of off-price offerings. Think TJX. The company thrived when inflation was rising. And it continues to do so today, even as inflation recedes. This shows the enduring demand for a discount.

There also appears to be ample room in the wallets for consumables and other simple luxuries. Walmart has done well in taking share on this front. Dollar stores, such as Dollar Tree ( DLTR ), figure to carry similar momentum. Ollie’s Bargain Outlet ( OLLI ) is another name to watch and one that has been an under-the-radar outperformer, up nearly 60% YTD.

On the other side of the token are those that carry “easier to give up” discretionary offerings. Big-ticket product lines are the first to come to mind here. Home Depot provided an early indication of what to expect when others report results. There’s Lowe’s ( LOW ), which will likely provide similar commentary as HD.

But another that should be on watch is Big Lots ( BIG ). In Q1, results were significantly affected by a pullback in big-ticket purchases. Fresh news on BIG note that the company is working with an advisor as it seeks to shore up sales. This doesn’t bode well ahead of their earnings release at the end of the month.

Consumers are not only spending based on price but also by their ideological beliefs. Despite Anheuser-Busch’s earlier experience with this, Target remained undeterred. And it ultimately netted them a similar fate.

Fortunately, the setback will likely prove fleeting. Target indicated as much by pointing to their sales trend in July, still a decline, albeit a milder one than in June. For investors in TGT, the real concern is the pending restart in student loan repayments, which figures to be an even more prominent theme in the coming months.

Final Thought

All considered, selective retail holdings remain a solid investment in the current market environment. And those with greater exposure to the off-price and consumable categories are likely to outperform in the near-medium term.

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