Shares of Walmart (WMT) - Get Walmart Inc. Report, Target (TGT) - Get Target Corporation Report and other retailers got hammered last week after the two giants released weaker-than-expected earnings reports.
But the outlook isn’t totally bleak, says Wells Fargo analyst Edward Kelly.
“While every retailer seemingly has earnings risk now, we don't expect our other names to have as poor results” as Target, he wrote in a commentary. “The market has already discounted a lot, and there is real value at current levels.”
To be sure, “we get the hesitation to catch a falling knife, and there is no guarantee this market buys ‘less bad’ results, but we see particularly attractive opportunity in:
· Dollar General
“Dollar General’s risk is the low income consumer, but the stock is once again discounting a lot,” Kelly said. Shares have dropped 21% since May 16, the day before Walmart announced its earnings.
As for Dollar General’s exposure to low-income consumers, “the company is helped by the fact that it's small ticket, consumable heavy, and a trade-down format,” Kelly said.
“But many of its customers live paycheck to paycheck and are under increasing pressure, with the cost of food, gas and other essentials up materially versus last year.”
Kelly does see some risk Dollar General won’t meet its initial comparable sales guidance. But, “we don't expect anywhere near the same level of unexpected markdown/supply chain pressure we saw from Target,” he said.
That’s because of the smaller weighting for discretionary items in Dollar General’s sales (around 20%), its lack of big ticket items, and a cleaner inventory position coming into the year, Kelly said.
“In the worst case scenario, we believe a high-single-digit percent full-year guidance cut is possible when the company reports earnings [May 26],” he said. “But much of that seems priced in at this point.”
Bottom line: “we like the stock here, especially given that expectations have fallen considerably,” Kelly said.
“Walmart has just sold off too hard. Quality defense is on sale here,” Kelly said. The company’s stock has slid 16% since May 16.
“In hindsight, Walmart's first-quarter update actually looks good now, as it only lowered guidance by 5%," Kelly said.
In addition, the earnings report “indicated that most of its issues (labor, general merchandise markdowns, high fuel costs) have been or are being addressed in a timely manner,” Kelly said.
Also, “the company didn’t express concern around ocean freight in our call back.”
In the big picture, “Walmart has qualities investors should want in a defensive name at the moment, as its leading price gaps should yield share gains as consumer trade down,” he said. “And it is in the best position to push back on additional vendor pricing.”
To be sure, “we do have some concern that maybe Walmart didn’t cut guidance enough after Target’s [earning report],” Kelly said.
“But the stock price already seems to account for this risk. We would be buyers of WMT at current levels,” Kelly said. Walmart was then trading at $119.50. It recently stood at $123.95.