Finding a bargain in retail stocks is getting difficult.
The sector has been very strong for the past nine months. Since bottoming in July, the S&P Retail Index is up more than 24%, outpacing the
's 19% gain in the same period.
Measured on a price-to-earnings basis, many retailers are fairly valued or even trading at a premium.
is trading at 20 times trailing 12-month earnings and 21 times forward earnings, with buyout rumors buoying the stock despite a poor performance at its stores.
is at 42 times trailing and 22 times forward earnings.
However, when you take growth into consideration, retailers are projected to post some impressive numbers. Within the group of over 150 retailers and restaurants that I track, the apparel group is expected to grow profits 16.7% over the long term, according to consensus estimates. Electronics and grocery stores are predicted to achieve growth of nearly 16% each.
It's OK to pay a higher multiple for growth. If you have a company such as
that is expected to expand earnings nearly 18% over the long term, a forward multiple of 20 is reasonable.
That said, there are still a few good deals left in the sector. I combed through my data base to find some cheap stocks and whittled down the list after looking at the fundamentals. Here are some of the best value plays in the retail and restaurant space.
Cheap Goods, Cheap Stock
When it comes to the dollar stores, many analysts are as nervous as a sober karaoke singer. Rising gas prices, inflation and worries about a slower economy all could hit the stores' target demographic of middle- and low-income consumers.
Nevertheless, Kohlberg Kravis Roberts thought enough of
and its prospects to offer $7.3 billion for the company. The firm is paying a 31% premium over Dollar General's closing price the last trading day before the deal was announced.
operates more than 700 stores in 15 states, mostly in the south. At around $14.70, the stock sports a forward P/E of 18.4, the lowest among the discount stores. That relatively low valuation comes despite a projected long-term growth rate of 13.7%, which is second only to
and well above the 12.9% industry average.
The company's price-to-sales, price-to-book, price-to-cash-flow and price-earnings-to-growth are all the lowest among its peers.
Fred's margins are lower than many companies operating in the same segment, which is perhaps why Wall Street is hesitant to give it a multiple in line with its group. However, the company has taken steps to boost margins, including cost cuts and shrinkage control.
Additionally, Fred's has put pharmacies in nearly half of its stores, which provides another revenue source and also encourages repeat visits to the stores.
While I'd like to see margins improve (and believe they will), the deep discount is unwarranted. If you take into account various valuation metrics, a $20 stock price would put Fred's in line with its peers.
Plus-Size Clothing, Waif-Like Valuation
, the proprietor of the Lane Bryant, Fashion Bug and Catherine Plus Sizes chains, has seen its shares go on sale. The stock has slid from around $15 in late October to about $12.50 today, likely because the company lowered guidance in March amid lower catalog sales and tepid same-store sales.
The stock is dirt cheap. It's trading at just 14.5 times projected earnings of 86 cents a share and one times its 14% long-term growth rate. The stock is also a bargain in terms of other metrics, trading at 0.5 times sales and 7.7 times cash flow.
Wall Street doesn't seem to be putting much value on Charming Shoppe's 40% market share in women's plus-size apparel. The company has plans to ramp growth; it expects to open 50 to 60 Lane Bryant stores on a net basis to go along with the 44 already in existence. The retailer also expects to grow gross margins this year, building on an 80-basis-point rise last year.
Management has done an effective job, according to Thomas Filandro with Susquehana Financial Group. "Carryover inventories were down 15%, reflecting well managed clearance to ensure appropriate positioning entering 2007," he recently wrote.
Brian Culpepper, portfolio manager of the
James Small Cap fund, which owns shares of Charming, wasn't scared off by last month's lowered guidance.
"The bad news is out," he says. "Often when a company lowers guidance, they lower it enough so they can beat it."
To say that Charming Shoppes is in the sweet spot is an understatement. According to
, women who wear sizes 14 and up represent more than half of the overall apparel market. Plus-size is the fastest-growing category.
So while the retailer goes through some growing pains, opening its Lane Bryant stores and getting its catalog business back in a groove, investors have an opportunity to buy a stock of a company that has proven its ability to understand and leverage trends. The wait should be worth it. I believe the stock can trade up to $18 without being overvalued.
One caveat: The technicals concern me. I'm a little worried that we're seeing a double top. If the stock breaks the $11.50 area, there's a good chance of shares heading significantly lower. I would like to see the stock break $13 to the upside to feel more confident about the price action.
Put Bucks in CHUX
The casual-dining sector is fiercely competitive and is facing many of the same economic headwinds as the discount retailers. So when searching for bargains in the industry, you'll most likely find a turnaround play.
( CHUX) had a rough few years. However, in 2006, management was overhauled, and performance began to improve.
With a focus on cost containment, management trimmed 70 basis points off of the cost of food in the fourth quarter by concentrating on waste. The company also cut labor costs by 160 basis points in the fourth quarter.
These steps helped boost operating margin for the full year to 4.1%, which is still low but is an improvement after three consecutive years of declining margins. O'Charley's also is slowing down expansion, focusing efforts on store remodels and continuing to improve margins.
If O'Charley's can show that it's continuing to contain costs while growing the top line, I believe $27 is a realistic stock target, compared with its current price of about $21.
The three-concept restaurant chain still has a way to go. Same-store sales at the flagship O'Charley's were negative in 2006, and the company expects comps below 2% in 2007. Despite the weak same-store sales, management expects earnings to grow 25% to 38% this year.
O'Charley's is currently trading at 20.5 times forward earnings, compared with 23.2 times at the average restaurant. On a growth basis, it's right in line with the group.
However, the stock is at just 1.3 times book, 0.5 times sales and 7.8 times cash flow. These kinds of metrics make the company appear attractive for an acquisition -- particularly when it is slowing expansion and the capital expenditures that come with it. Meanwhile, O'Charley's balance sheet still has room to be levered up, which could appeal to a private equity group.
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;
to send him an email.