Just as we saw in the previous month of July, executive turnover in North America continues to slow down from the rapid rate we experienced for most of the last year. The recent slowdown in executive turnover has not been dramatic and we anticipate turnover will begin to grow again as we move into the Fall and Winter months. Last Friday morning the U.S. Department of Labor’s Bureau of Labor Statistics released its highly anticipated August 2012 Employment Report, The Gallup Organization on September 6, released its unemployment numbers for August and earlier in the week, ADP released its Private Employment Report. All three reports showed poor progress in job growth and a small reduction in overall unemployment.
The Labor Department’s BLS Report stated,
The specialty hardlines retailing sector tends to be correlated with the state of the U.S. economy, including consumer confidence, the unemployment rate, personal savings rate and the housing market, which continues to be challenging; however there are some key indicators of improvement, including housing turnover and prices, says Anthony C. Chukumba, Senior Vice President and Senior Research Analyst for BB&T Capital Markets.
“On the other hand, consumer confidence is still pretty depressed relative to historical norms, the unemployment rate is stubbornly high and GDP growth is anemic. Overall, I would say it is a pretty mixed picture out there,” he said. “It is tough to place all of these companies in the same boat, because the macroeconomic environment affects them in different ways.”
Chukumba likes Pier 1 Imports, Inc., (PIR), the eclectic home furnishings retailer. Even though Pier 1 has completed a successful multiyear turnaround plan, the company’s sales productivity is still well-below historical peak level. He also likes the fact Pier 1 generates strong free cash flow, which the company consistently returns to its stockholders through share repurchases and cash dividends.
“In addition, Pier 1 has dramatically reduced its cost structure, so I think future profitability has the potential to be well-above historical peak levels. The company just recently reintroduced an e-commerce-enabled Web site, which provides a major growth opportunity going forward, particularly given the secular shift of U.S. consumers increasingly shopping online,” Chukumba said.
The key to being hedged as much as possible in the department stores, broadline, multiline retailers and supermarkets sector, is to avoid the middle-income consumer as part of a “barbell strategy” by owning the best-performing names at the high end and the low end of the sector, says Charles Grom, a Senior Equity Research Analyst and Managing Director for Deutsche Bank Securities Inc.
“The strategy we try to embrace is to find retailers that have got decent square-footage growth stories, that have got solid comps led by traffic as opposed to ticket; companies that have very good balance sheets, and then on top of that, companies that have got operating margin opportunities,” he said.
Grom favors Nordstrom Inc. (JWN), a high-end department store, which has been up about 13% year to date, and has raised its guidance. He says Nordstrom has inventory levels in control and has reported a healthy second quarter with better-than-expected gross profit margin improvement and comps that were up roughly 3% to 5%. Grom also sees Nordstrom benefiting from the retail trend of department stores trying to capturing the move by consumers to online shopping.
“Nordstrom’s is really the model for that. They’ve done a great job in the past five, six years developing systems and having the back-end infrastructure to satisfy customers’ needs, whether they’re shopping online or shopping in the store,” he said. “They reinforced this with a third development, which is primarily only affecting the high-end names, which are offering discount divisions like Nordstrom Rack line.”
Price increases and higher enrollment are expected to drive continued topline growth in China’s education market despite the country’s macroeconomic slowdown, says Ella Ji, an Executive Director and Senior Analyst for Oppenheimer & Co. Inc.
“For example, take the after-school tutoring market, which is a very popular sector now. Almost all of the companies that I cover are involved in this sector. The after-school tutoring sector is now valued at a market size of over $20 billion, and it’s still growing, as I said, in the midteens, driven by price increases and also enrollment increases,” she said.
Ji recommends TAL Education Group (XRS) as the company recently achieved more than 40% topline growth. She says TAL Education is known for its high quality of tutoring services, and its students achieve high scores among national competitions, and also during college entrance exams, which boosts its enrollment despite increased pressure from peers.
“I always like companies with strong brand names and differentiating products or services. I think they are better equipped to win out and gain market share among this very intense competition. This is because tutoring services is an old-fashioned industry. There is nothing really fancy about it. While this market has thousands and thousands of players, it is important to differentiate yourself from your peers,” Ji said.
Consumers are increasingly spending on active lifestyle items, leading to growth among retailers focused on the fusion of fashion and function, says Sean Naughton, CFA, a Vice President and Senior Research Analyst at Piper Jaffray & Co.
“These are all companies that are clearly benefiting from trends within this entire lifestyle,” he said. “Whether it is chips inside of shoes or tracking on shirts to monitor heart rates inside of your body, I think those are the types of initiatives that will continue to drive innovation in that category and continue to drive share of wallet with the consumer.”
Naughton favors Dick’s Sporting Goods (DKS). He says the company is well positioned in the marketplace to continue to take share as its two largest brands continue to compete against one another, and that innovation is helping to create merchandise. Importantly, about 25% of that merchandise is exclusive to Dick’s Sporting Goods, and Naughton believes that should continue to drive consumers into the store and lead to higher sales trends.
“Dick’s Sporting Goods is also going up against some relatively easy comparisons as we get into the fourth quarter. Last year, cold weather apparel and equipment really did not perform well given the warm weather,” he said. “We believe a normal winter this season leaves an opportunity for the company to exceed the expectations currently in the marketplace for the fourth quarter.”
The online business side of the for-profit education sector is expected to face more competition than the on-ground segment due to traditional schools and new learning technologies having a bigger impact on the online space because of the opportunity for consumers to shop more schools, and as traditional schools utilize their brands to attract prospective students, says Brandon Dobell, a Partner and Group Head, Global Services, at William Blair & Company, L.L.C.
“So online, we think, has a lot more competition. I think there’s still a good secular growth story there, because online is much more convenient, and in some cases is better suited, for the adult learner than an on-ground program,” he said. “But you’re going to have a lot of pressures from competition and from the rules that have changed around how you deliver and what you have to track for the students.”
Dobell likes Grand Canyon Education, Inc. (LOPE) due to its combination of low tuition price point, solid brand and management team, which is focused on not only academic quality but the impact of what that quality can do for financials. He says LOPE recently put up new enrollment growth, solid continuing population growth and raised its guidance.
“From a fundamental perspective, the thing that sticks out for us is the interplay between population growth and revenue-per-student growth. You are seeing more scholarships and discounting from a number of schools, but you are seeing improving retention at some schools, and those were all factors that really can impact our revenue estimates on a forward basis,” Dobell said.
The bulk of the growth the discount retail space is seeing is coming from middle-income households, so the way to approach this sector is by looking at the middle 60% and seeing how their shopping patterns have changed over the past couple of years, and the middle 60% income range is becoming much more value seeking, says Dutch Fox, a Research Analyst at FBR Capital Markets & Co.
“Frankly, the entire discount space is really on fire right now. They’re all the seeing remarkably good success,” he said. “The reality is within the discount space, you are not seeing too much of a change in the lowest 20%, they have always frequented discount retailers. And the highest 20%, in terms of income, your wealthier households, for the most part, have really survived this recession fairly well and continue to do what they have always been doing.”
Fox favors Ross Stores Inc. (ROST) because it is in the middle of a longer-lasting secular shift in shopping patterns as people in that middle 60% of income are less likely to make aspirational purchases, and are more likely to seek value. From a stock-specific perspective, he says retailers in this space are compared on a year-over-year basis, and Ross has comped strongly for the past year, as it is trading around 18 times earnings, whereas other comparable retailers are trading at 10 to 12 times.
“I understand that the sentiment is poor right now, but if you look at the hard numbers, we are adding jobs slowly but surely. Consumers’ ability to spend is not fantastic but it’s slowly getting better,” Fox said. “So compared to a year ago — and keep in mind that retailers trade on year-over-year comps — on a year-over-year basis, there really are more people working. There is more money out there for the consumer to spend.”
For-profit education companies focusing on low tuition and student outcomes are poised to succeed, as those are becoming the most important factors for most prospective students, says Jeffrey Y. Volshteyn, a Vice President at JPMorgan Chase & Co.
“Schools with low tuition have better new enrollment metrics than the others, for all the reasons that we’ve discussed,” he said. “Within the group, low-tuition providers’ new enrollments in 2011 were up 16% versus a decline of 6% for the higher-tuition providers.”
Volshteyn favors American Public Education (APEI), whose tuition is about 20% lower than in-state tuition at many state institutions. APEI’s heritage is in military student education, and over the past several years, the company has expanded into the civilian market. He says a lot of APEI’s students come on referrals, which he sees as a positive sign of the quality of education and a positive student experience.
“APEI is very impressive in the way they have been able to hold their tuition flat for about 10 years, despite rapidly escalating college costs everywhere else. APEI has highly qualified faculty who have been cited in numerous industry publications as thought leaders in the area of online learning and student outcomes,” Volshteyn said.
Solar module manufacturers moved buildout capacity ahead of demand in 2011, a problem that persists today and which is exacerbated by the slowdown caused by subsidy resets in Europe and the U.S., says Ben Kallo, an Analyst at Robert W. Baird & Co.
“But really it’s building out capacity, and mostly this is Chinese manufacturers that built out capacity, which has outstripped demand. What I’ve continuously looked for to become more positive is a slowdown, and then even a curtailment of capacity,” he said.
Kallo points to First Solar, Inc., (FSLR) as an example of a company that is reducing capacity in the solar manufacturing arena. He says FSLR has undergone restructuring and is more focused on the balance sheet side of its business in moving to markets that aren’t related to subsidies.
“This could be in South America, this could be in Middle East, North Africa. And so this is an evolution of a business model where I’m purely a module manufacturer to where I’m actually making energy products. I’m acting more like an engineering procurement construction firm,” Kallo says.
The water services industry offers investment opportunities after companies have lowered guidance this earnings season, coupled with a stock pullback due to pressure from slowing macroeconomic data points in the U.S. and Europe, says Hamzah Mazari, a Senior Analyst at Credit Suisse Group.
“The water side, it seems like a good investment right now because in a slow-growth environment what you are not going to get is cyclical pop. You want to be in companies that are diversified, that have high-margin aftermarket business as well as the other thing to point to is the balance sheets are in very good shape for the water companies,” Mazari said. “They are not very levered, they generate good cash, and so we also like that fact, especially in an environment that is slowing.”
Mazari recommends Pall Corporation (PLL) because he expects 300 to 400 basis points of margin improvement due to cutting costs and streamlining operations. He says despite Pall having European exposure, most of the European business is levered to the biopharma, health care, general industrial and energy, all of which he believes are strong.
“We also like that name because they are going to be sitting on a lot of cash, almost $1 billion of cash because they sold one of their businesses, and we think that they should be returning that cash back to shareowners particularly because we don’t think there is any large acquisitions,” Mazari said. “And also, they’ve got a balance sheet that’s pretty underlevered, so it’s not like they have to pay down any debt either.”
