Inflation has taught shoppers to bargain hunt. Investors should do the same with retailers.
The off-price chains are the best bets right now, according to Wolfe Research's Spencer Hanus, who initiated coverage of the specialty retailer sector on Thursday.
It isn't just that consumers are being squeezed by higher prices. Many full-price retailers are struggling not to overstock so they can keep selling without discounts.
That sets the stage for off-pricers, wh0 can snap up that excess inventory on the cheap. Plus, the earnings miss by TJX Cos. a couple of months ago spooked some investors, weighing on the group's valuation -- and providing a good entry point.
Hanus' favorite of the group is Ross Stores, also a Barron's stock pick, because of its new management team's goals of expanding the brand's footprint and improving its marketing. His rating is Outperform and his price target is $279.
Another name that Hanus likes is Burlington Stores, rating it Outperform with a $355 price target. He's confident that its turnaround will keep bearing fruit.
But Hanus has names he doesn't like, too. He's bearish on apparel and footwear companies, particularly those with athletic lines, for three key reasons: They have most problems managing inventories, they aren't innovative, and their customers aren't very loyal.
The stocks are under pressure, and Hanus thinks there could be more downside ahead because earnings estimates are being revised lower. He rates Nike and Lululemon Athletica at Underperform, with price targets of $28, and $75, respectively.
"Nike is in the midst of a multiyear turnaround as US/China demand slows, full-price sell-through wanes, and competition intensifies," Hanus writes. "lululemon is also ceding [market] share to Alo/Vuori with an earnings reset likely."
Barron's has had questions about both stocks as well.
On Holding is the exception for Hanus. It's another top pick for him.
On's strong innovation means it can sell more products at full price, rather than margin-crunching discounts. The stock was at $34.23 on Thursday, and he thinks the shares should trade to $47 -- roughly a 37% increase.
And, he said, sentiment has gotten too negative on Dick's Sporting Goods. A fair value is $181, more than 25% above Thursday's $148.52.
Nonetheless, even the strongest operators have to overcome investor skepticism about consumer stocks in general. The State Street SPDR S&P Retail exchange-traded fund and State Street Consumer Discretionary Select Sector SPDR ETF have both badly trailed the broader market since the start of the year.
Although retail sales have held up, consumers are in a sour mood because of inflation and worries about climbing gas prices.
Their mood just might brighten, though, in time for the crucial holiday shopping season, which would let the strongest retailers to show that they haven't lost their mojo.
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