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What retailers to buy in a slow economy

Stick to discount retailers and best in class

What retailers to buy in a slow economy

By Darcy Keith
Globe Investor Magazine online, June 4, 2009

Given the severity of the economic downturn, tighter limits on consumer credit, and ravaged retirement portfolios, many speculate a new era of belt-tightening and value-focused shopping has only just dawned.

According to a recent U.S. survey conducted by America’s Research Group Ltd. of Charleston, S.C., 51 per cent of consumers said they expect to work three to seven years past their originally planned retirement date due to the stock market decline last fall.

“That’s why I think this whole frugality is going to last a long time, because if I have got to work three, five, or seven years longer, I’m going to be more careful with what I buy in the future,” said Britt Beemer, chairman and founder of the consumer behaviour marketing firm that did the survey. “We’re definitely seeing a shift in consumer spending habits.”

Mr. Beemer says his recent surveys, when looked at in aggregate, suggest a whopping 98 per cent of consumers have curtailed their spending in recent months, and he predicts this “retail deep freeze” will last for another 15 months.

In the longer term, there are ominous signs as well. A recent poll of 5,000 U.S. consumers by Alix & Partners predicted that post-recession spending would go back to just 86 per cent of pre-recession levels. A Citigroup report argues that U.S. consumers are shifting towards “conscientious consumption,” embracing a “thriftiness” based on value and quality, not quantity. For investors, the message may be to stay clear of luxury retailers and focus on the discounters that can benefit from consumers clinging to their thrifty ways.

“Wal-Mart (WMT-N) may move from being the 800-pound gorilla to the 1,000-pound gorilla,” said Mr. Beemer.

He suggests other value-oriented retailers, such as Aeropostale Inc. (ARO-N) and TJ Maxx, a unit of the TJX Companies Inc. (TJX-N), should also do well. High-end names, such as Saks Inc. (SKS-N), are riskier bets, particularly if they carry high debt loads. “I think in 10 years you may see consumers feel better about things and you might see a bit of a recovery, but the point is, in 10 years many of those luxury retailers will be gone,” said Mr. Beemer.

Tough times also mean people tend to return to their roots and seek out brand names they know and trust. That’s particularly true of Canadians, Mr. Beemer says. Unless there is a big discrepancy in price, Canadians will often go with brand names they are familiar with, such as Sony for TVs and Sealy for mattresses. So retailers such as Brick Group Income Fund, (BRK.UN-T) which sells products from mostly well-known names, are better poised for an economic recovery, he argues.

Murray Leith, vice-president and director of research for Odlum Brown Ltd. of Vancouver, also believes prospects are looking good for Wal-Mart Stores Inc., which is presently trading a few dollars above its 52-week low of $46.25 (U.S.). At the beginning of 1999, the stock was trading at 55 times earnings, and despite annual profit growth of about 10 per cent, the valuation multiple is now less than 15 times, he said. “It’s still a very attractively priced stock that has global reach and lots of potential for growing faster than your average company out there,” said Mr. Leith.

Mr. Leith also likes Shoppers Drug Mart (SC-T) given “a natural demographic tailwind” that will initially bring aging baby boomers into its stores for prescription drugs, but will have them leaving with other products as well. The company’s push into higher-margin private-label products will also be beneficial, he said.

Mr. Leith says the bottom line is to take a defensive stance when picking retail stocks, targeting the best-in-class operators, because consumer spending is likely to stay sluggish for some time. “It’s valuation that really drives returns and not just the general trend in the economy or retail sales,” he added.

Exchange-traded funds in the retail sphere don’t generally target only discounters. But one that may be worth considering is the PowerShares Dynamic Retail Portfolio ETF (PMR-N). Both Wal-Mart and TJX are top holdings. It has rebounded modestly from lows of early March of near $10.50 (U.S.) to about $14.

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