A strong economy bodes well for the retail sector. Our best bets include apparel, footwear, and home-improvement chains. By Sabrina Escobar
It was hard to make money last year in shares of retailers, unless you invested in Walmart, Costco, or Amazon.com. The SPDR S&P Retail exchange-traded fund, or XRT, gained just 10%, compared with a 23% increase in the S&P 500.
This year may be no better for the broader retail index, although shares of many companies, from apparel to footwear to furniture merchants, look appealing. It is "a great environment for stock-picking," says Michael Buck, a portfolio manager and senior analyst at Driehaus Capital Management.
While economists expect consumer spending to remain healthy, American households face economic challenges, from sticky inflation to elevated interest rates, that could keep a lid on excess growth. Likewise, retailers that benefited from leaner inventories and moderating inflation in 2024 might have to work harder to expand profit margins in 2025. Companies will be lapping last year's strong performance this year, and potentially navigating rising freight prices, port strikes, and the government's imposition of tariffs on U.S. trading partners.
The Trump administration's policies could produce headwinds and tailwinds for the retail sector. Both tariffs and efforts to reduce benefits such as SNAP, or the Supplemental Nutrition Assistance Program, could crimp consumers' spending power, while looser regulations could benefit companies, partly by encouraging more mergers and acquisitions. A lower corporate tax rate and the extension of the 2017 tax cuts could also help if Congress approves them.
Winners Keep Winning
Big-box retailers have been the biggest winners in the postpandemic years, and that trend is likely to continue. Walmart, Amazon.com, and Costco Wholesale have been gobbling up market share, and accounted for about 40% of U.S. retail sales in 2024, writes Bradley Thomas, an analyst at KeyBanc Capital Markets. A focus on value and convenience will continue to fuel their sales growth, he writes.
Additional revenue sources, such as Walmart's growing advertising business and Costco's membership fees, have contributed to earnings growth, which placed the stocks at the top of many investors' buy lists. The stocks aren't cheap, however; Walmart trades for 37.5 times this year's estimated earnings of $2.48 a share, and Costco, for an even loftier 52.3 times expected earnings of $18.13 a share.
Among specialty retailers, Canadian apparel company Aritzia, Western shoe retailer Boot Barn Holdings, Hoka parent Deckers Outdoors, and Swiss sneaker manufacturer On Holding all look primed to continue to outperform. Their shares saw big gains in 2024, which pushed valuations above 20 times earnings -- and in the case of On, to a little over 50 times next year's expected results. But investors don't seem to mind. "There's an appetite to pay more for the business models that are winning," says Mark Miller, chief investment officer at BlueView Investment.
Miller is particularly bullish about On, noting the company is "young enough" to keep driving growth. Boot Barn, based in Irvine Calif., also has room to expand the number of units sold as the company proceeds with plans to operate 900 stores in the next four or five years. It currently has 438 stores.
Janine Stichter, an analyst at BTIG, is also partial to Boot Barn. "BOOT is one of the last remaining unit growth stories in retail, while also offering a level of sales and margin consistency that should be afforded a premium in the current market," she wrote in a note this week. At a recent $160, Boot Barn sells for 28 times estimated earnings for the fiscal year ending in March.
Tom Nikic, an analyst at Needham, sees momentum continuing at Deckers Outdoors, with the company's Uggs and Hoka brands both delivering strong results. He calls management's guidance conservative and says he isn't worried that the market will become saturated. Deckers management recently guided for sales for the fiscal year ending in March to increase by 12%, with adjusted earnings per share rising 15% from the previous year.
Shopping in the premium-price aisle has its risks, however, as companies may fail to exceed investors' lofty expectations. Abercrombie & Fitch lost 16% on Jan. 13, its worst day in months, after the company's fourth-quarter profit margin and sales guidance disappointed investors. Abercrombie's stock rose about 70% last year.
Betting on the Underdog
The double-digit gains notched last year by some retail stocks left many investors with a case of FOMO, or fear of missing out. Yet, some on Wall Street prefer to focus on the next Abercrombie, or future winners. Driehaus's Buck says he is looking for beaten-down businesses that seem poised to inflect, propelled by new growth initiatives, management teams, product launches, or successful marketing campaigns. His team has identified discounter Five Below and apparel retailer Victoria's Secret as potential turnarounds.
Dylan Carden, an analyst at William Blair, is bullish on small-cap retailers J. Jill, a women's apparel brand, and Torrid Holdings, which sells plus-size apparel online. Both, he says, have improved their businesses and are generating cash flow, some of which could eventually flow back to investors. Both stocks sell for less than one times sales.
Theme Party
Thematic investing also could offer opportunities in the retail sector this year. Housing and home furnishing stocks look ripe for a rebound, says Buck, although their fortunes may hinge on the Federal Reserve's interest-rate-cutting cycle. Lower rates likely would reignite consumer demand for big-ticket household items such as furniture, electronics, and home-improvement products, which slumped in the past two years.
The Fed cut interest rates by a percentage point last year, starting with a half-percentage-point cut in September. Fed officials have penciled in expectations for two more rate cuts this year, although much will depend on the course of inflation.
"The removal of one of the most significant headwinds to industry growth over the last several years sets up a more favorable backdrop for demand in 2025 across hardlines/broadlines/food retail," Simeon Gutman, an analyst at Morgan Stanley, recently wrote.
Shares of home-improvement chains Lowe's and Home Depot have already benefited from expectations that lower rates will lead to an industry recovery. There could be more upside for the stocks if rates stay on a downward trend.
Eyewear is another category that could see fresh demand this year, some investors say. People often buy new glasses every two to four years, and industry data show that many purchased eyewear in 2021. That means much of the glasses-wearing public is due for a new prescription.
Investors have piled into Warby Parker in anticipation of a buying spree. But the stock has rallied about 90% in the past year and now trades at 79 times next year's expected earnings.
Eric Gandhi, a small-cap portfolio manager at Boston Partners, prefers National Vision Holdings, which he says could benefit from a broader recovery in retailers catering to lower-income shoppers. National Vision's sales trends are improving, and the company has reset its business model following Walmart's decision to end their longstanding partnership. The stock has fallen more than 50% in the past year, and sports a price/earnings multiple of 21, based on next year's expected earnings.
A strong economy may lift the broader retail index again this year. But savvy merchandising and management may boost some retail stocks even more.
Write to Sabrina Escobar at sabrina.escobar@barrons.com
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January 31, 2025 21:30 ET (02:30 GMT)
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