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Retail Report Cards: Time to go shopping at the Mauled?

By

"No rest for the Wicked! It's time to start prepping for Ojai!"

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This thing with the retailers is looking a little ugly. It's one thing for sales to be a little punk in July. July is a nothing month for retailers.

But August is serious. It's the second biggest month of the year with back-to-school and changing seasons driving sales. It's a harrowing thing to hear the companies complaining about gas and saying bad things about the 3rd quarter already.

American Eagle Outfitters (AEOS), to take one example, had been on fire. Today they missed and warned for a quarter which is only 3 weeks old. That's pretty much the danger of specialty retail, on display.

In the spirits of both back-to-school and prepping cliff notes for my Ojai chat on fundies, let's do a quick review. Like all decent study guides, we'll try to keep the cases within the context of the bold and italicized larger themes to keep in mind, when sizing up retail stocks.

I can't speak for the other professors but I never promised anyone that there wouldn't be a final exam at the conclusion of my session. Substandard grades on such a test, should I choose to administer it, will go down on a Minyan's permanent record, so pay attention, Mr. Collins! [Glaring menacingly at Collins, poised to fire a spit ball in Meehan's direction]).

Wal-Mart (WMT), misses, warns for current quarter.

The company blamed fuel for hurting margins and crimping demand. The stock is getting quasi-whacked for over 1.50. We can draw two important, related, lessons from this fact set.

When in doubt, sell any retailer that blames a shortfall on Factors Outside Of their Control (FOOC).

If a negative business trend accelerates, and the retailer in question resorts to blaming a FOOC, the stock should be considered toxic to the (long-side) touch, until further notice.

Wal-Mart is moving into "consumables" (read: food) in a big way. If you paid attention to either our retail round-up, prior columns or WMT's own once widely-reported, now discontinued, weekly sales updates, you could hear WMT themselves discuss the relative strength of food, over apparel and other, higher margin, categories.

You could also hear WMT CEO Lee Scott discussing his optimism that a move into affordable home electronics would drive sales.

As a rule of retail thumb, broad categories have roughly the following gross margins:

    • Apparel: 50%
    • Electronics: 25%
    • Consumables: 15 - 20%

We know that the company's growth categories have lower relative margins than its traditional strong-suits. This trend has long been in place. Now, margins are looking particularly soft. Wal-Mart blames oil.

The problem with the FOOC explanation is that the logical extension of it leads you out of the stock in question, regardless. If Wal-Mart really thinks oil is (primarily) to blame for ever declining margins then we obiously shouldn't hope for organic margin improvements... they aren't even thinking about that. They are watching, and blaming, oil.

If oil really is a great excuse for weak margins, why own the stock? There are better ways to bet on a decline in oil than via Wal-Mart. Even if oil does decline, we're obviously stuck with ever-weaker margins in their core business.

Owning Wal-Mart is particularly dicey as an option when we consider that...

Target (TGT) beats consensus by $0.02, says better gross margins offset higher expenses.

Now that would be the way a company should mention the FOOC issues (which always exist): as barriers easily surmounted on the road to glorious triumph.

Our lesson?

If you want to be long a retail sector, stick with the leaders who are executing, not pending "trend reversals"

The operationally challenged co's always look "cheaper" on a multiple basis. Buying the weak-sisters (or brothers) waiting for them to turn things around is the expressway to dead-money in retail.

(And, yes, this rule still holds in today's age of private equity ever poised to bail investors out of the Circuit City (CC) of the world. "The Greater Fool" has a penchant for only arriving after you've sold a dog.)

Abercrombie & Fitch (ANF) doesn't do much of anything wrong, gets marked down by around 20% in one month.

Specialty retail is the sector where love goes to die.

Growth always slows. Fashion trends reverse. Expectations get too high. Herds of "day-trading-self-styled-Peter-Lynch-types" overreact to the slightest move.

Save your explanation for the essay portion, Minyans, and don't misconstrue what I'm saying as a warning to never be long specialty retail. Far be it from me to ever suggest such a thing.

I'm just saying that I'd rather be out of them early than late. They tend to end nice runs with a Thump, they can go lower than you think and paying capital gains taxes is both a patriotic duty as well as something about which it's bad Mojo to complain.

On a related point, feel free to take a loss, when disappointed (*cough... Hot Topic (HOTT)... *grrrr cough-cough). Another possible essay question here, though the main point remains "don't fall in love".

You'll ignore this advice. Everyone does. Just know this: when you fall in love with the BeBe (BEBE)'s of the world they take you on an exciting, wild ride. Right when you think it's going to last forever she'll disappear with your money and your heart, leaving you in a perfumed fog of remorse. You won't know what hit you. Hey, BeBe is down 25% and they still haven't done anything wrong.

It's the nature of the specialty retail beast. Think "fling", never "marriage".

Which is what I told Collins and Mbop last night, when they called enroute to Tijuana. Not that it helped. Like I said, most folks insist on learning this stuff the hard way.

No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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