New Year, New Rules: Searching for Value Amid the Retail Rubble

If the rules are changing for retail investors, it sure doesn't seem like it's for the better.

Tuesday's Stories

New Year, New Rules: As Demand Ebbs, Chip Stocks Look Broken

New Year, New Rules: Searching for Value Amid the Retail Rubble

Happy New Year. Proceed With Caution

Will 2001 Be Haunted by the Specter of the Four E's?

Pros Offer Allocations for 2001. You Don't Have to Follow Them.

Click here to see Monday's stories

It seems like just yesterday that Wal-Mart(WMT) was growing same-store sales by more than 6%, Amazon.com's(AMZN) stock traded at $100, and Tommy Hilfiger(TOM) was a hot brand with the high school set.

But thanks to interest-rate increases, Nasdaq investors' discovery of the profit motive and fashion faux pas by specialty retailers, the landscape for most retailers and e-tailers changed for the worse in 2000. One by one, most retailers saw sales and earnings growth slow, while consumer e-commerce companies found themselves more out of favor than Barbra Streisand at the Bush Inaugural. And the bottom may not yet be here.

Before looking at the issues nagging individual companies, you've got to address the macro question: whither consumer demand, which has declined this year amid higher interest rates, higher energy prices and a belly-flopping Nasdaq? Alan G. and the boyz might provide some respite, many argue. Even so, with the economy running into stormy weather and many of the best-performing retail stocks priced at nosebleed levels, there's no sure hit among these stocks for the time being, investors and analysts say.

Value Talk

Retail stocks will improve "when the Fed starts reducing rates," says Jeffrey Feiner, who follows retail for Lehman Brothers. "There's a direct correlation." For now, he likes value-oriented stores like Wal-Mart, Costco(COST), Kohl's(KSS) and Target(TGT). (He rates all four a buy and Lehman hasn't done underwriting for the companies.)

It's entirely possible, though, that a soft landing will simply mean a slower rate of growth in same-store sales (sales at stores open at least a year) and in profits. That's something that investors would just have to get used to. And while companies face easier sales comparisons after the first quarter and these stocks have certainly come down this year, there's been a recent shift in their direction -- possibly an excessive one, think some. "We've seen so much rotation into retail and restaurants because it was a safe haven from tech," says one East Coast hedge fund manager. "We have more [downside] to go -- we have to get rid of the stupidity there."

There aren't too many companies left that haven't disappointed, but those that remain command quite a premium -- stocks like Talbot's(TLB) and Tiffany(TIF), which trade at 27 times trailing earnings, or Kohl's, which trades at a whopping 60 times earnings. A miss at any of those untouchables would be, well, bad.

Moreover, in addition to the garden variety slower sales seen by the likes of Wal-Mart, Home Depot(HD) and Williams-Sonoma(WSM), there are plenty of companies with, as therapists like to say, serious issues. Will Gap(GPS) get back on track after its near-deadly brush with turquoise leather jeans? (The holiday season isn't likely to be its salvation, thanks to discounting.) Can new CEOs revitalize chains like Sears(S), J.C. Penney(JCP) and Kmart(KM), which look like 10 miles of bad road next to rival Kohl's? (Big changes take years to implement; will investors be patient?) Will Circuit City's(CC) remodeling campaign save it or prove disruptive?

Another One Bites the Dust

And how many more e-tailers will bite the dust in 2001? Up until the spring, these companies were told to lose money like crazy to get big. The rules changed, and everyone decided that profits are pretty important, too. Since then, there's been a steady dirge for companies like Pets.com(IPET) and Garden.com(GDEN). There are still plenty of e-tailers left, most trading close to a buck. No one is expecting them to put bricks-and-mortar companies out of business any time soon.

That just leaves the biggies. With priceline.com(PCLN) now looking like just another online travel company, all eyes are on Amazon and eBay(EBAY). The first needs to prove that newer categories like consumer electronics can be successful. Analyst Adria Markus with Epoch Partners likes the deal the company struck with Toysrus.com to share toy-selling duties. "They have an incredibly strong brand, but they're helped by category leaders in the off-line world," she says. If the toy thing works, look for more similar arrangements. (Amazon would also win friends and influence people by disclosing when it will make money.)

eBay, meantime, already earns money, but has seen its share price lopped by 70% this year due to wider Nasdaq stock woes and worries about slowing growth. New ventures like fixed price site Half.com need to continue to hit to maintain growth, says Markus. (Her firm does not issue ratings and has done no underwriting for either company.)

The lesson for the year ahead: Whether you're bricks, clicks, mortar or some combination, earnings matter. Margins matter. Sales matter. It's tough out there. Sounds like an interesting 2001, no?

>To order reprints of this article, click here: Reprints