Snap Up Retail Stocks

The sector can run despite April's dismal outlook.
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Retailers have reported their March same-store sales figures, and for the most part, the numbers were huge.

Thomson Financial's same-store sales index climbed 6% for the month, higher than the expected 4.2%. Teen apparel was the strongest-performing group, with a gain of 11.6%, amid standout performances from

American Eagle Outfitters

(AEO) - Get Report

and

Aeropostale

(ARO)

.

Despite my propensity to sell on good news, I believe the sector still has room to run.

April Showers

March's

robust sales weren't much of a surprise. The early Easter this year drew in shoppers during the month, meaning that many dollars spent in March won't show up in registers in April.

Nearly all of the companies expect lower numbers next month. For instance, after smashing analysts' estimates with a 15% rise in March same-store sales,

Nordstrom

(JWN) - Get Report

expects comps to rise in the low-single-digits in April.

Similarly, several retailers suggested not putting too much stock in the March numbers and instead combining the March and April figures to get a more accurate read on the health of the business.

Rob Plaza, an analyst with Zacks, doesn't see any positive catalysts in the sector until the back-to-school season begins in late summer. He says with positive news flow, gas prices poised to climb another 10 percent and interest rate cuts off the table, "Now is a good chance to take some money off the table."

On the flip side, Wall Street Strategies research analyst Brian Sozzi isn't overly concerned about gas prices.

"There's always going to be another concern," he says, predicting that retail stocks will rally over the next several weeks. Sozzi especially likes proven names such as American Eagle and Aeropostale and turnaround plays

Pacific Sunwear

(PSUN)

and

BJ's Wholesale Club

(BJ) - Get Report

.

Signs of Strength

The teen retailers are on fire. Along with American Eagle and Aeropostale's double-digit gains,

Abercrombie & Fitch

(ANF) - Get Report

reported 7% same-store sales growth and even

Hot Topic

(HOTT)

reversed 23 consecutive months of negative comps with a 3.4% gain.

Importantly, at many retailers, customers snapped up spring merchandise, which tends to be full-priced in March. Contrast that with

Gap

(GPS) - Get Report

which ended a 13-month losing streak with a 6% comp rise, or

Limited Brands

(LTD)

and its 8% figure, which both said margins were hurt by heavy discounting.

Wal-Mart

(WMT) - Get Report

, which reported a better-than-expected 4% same-store sales rise, could see margins hurt by the sales mix. Food, one of its strongest categories in March, is a low-margin segment.

Reasons to Buy

With so much good news already in the sector, why aren't I suggesting lightening up?

After all, the retail resurgence is not new. The S&P Retail Index has nearly doubled the return of the

S&P 500

since each bottomed several years ago. Year to date, the retail index has widened that beta, returning 3.4% to the broader index's 1.6%.

But the sentiment among Wall Street analysts still stinks. For example, best-of-breed retailer

Costco

(COST) - Get Report

only has six buy ratings, compared with 16 holds and two sells. American Eagle is similar, with six buys, 18 holds and three sells. Even

Kohl's

(KSS) - Get Report

, which has been a solid performer, only has 14 buys against 11 holds.

There's still room for a lot of upgrades, which could propel the stocks higher. And don't for a minute think that if these stocks get going, analysts won't upgrade them. They're not going to want to answer questions of why they sat on the sidelines while the stocks in their coverage universe climbed 20% or more.

Valuations aren't cheap. For example, the 24 apparel stocks that I track are trading at a forward price-to-earnings ratio of 20. Nevertheless, many retailers are finding ways to cut costs while enhancing the customer experience, either through better service or better-quality goods. And while I am concerned about rising gas prices, I believe the

subprime fears are overblown in regards to retail.

Private equity and merger activity could also lift the sector. With so much money sloshing around looking for a home, cash-flow-positive retailers (some with good real estate) could be where those dollars end up. We recently saw Kohlberg Kravis Roberts announce it would acquire

Dollar General

(DG) - Get Report

for more than $7 billion, at a 31% premium to the stock price at the time. This, in a segment that is believed to be most exposed to macroeconomic problems.

I don't think these are stocks to buy, put away and forget about; the window to buy retailers will close soon. I can foresee the time where the story is old, the stocks are expensive and the charts start to fail. But for the time being, I believe the group will continue to outperform.

In keeping with TSC's editorial policy, Lichtenfeld doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.

Marc Lichtenfeld was previously an analyst at Avalon Research Group and The Weiss Group and a trader at Carlin Equities. He holds NASD 86, 87, 7 and 63 licenses. His prior journalism experience includes being a reporter/anchor for On24 in San Francisco and a managing editor of InvestorsObserver, a personal finance Web site. He is a graduate of the State University of New York at Albany. He appreciates your feedback;

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