When investing in specialty retail, focus on U.S. companies.
Since many tend to operate primarily within the U.S., you “don’t have to worry as much about weak demand from China or Europe,” or about hedging currency exposure, says David Hollond, CIO of U.S. growth equity, mid- and small-cap, at American Century Investments. He manages the Renaissance U.S. Equity Growth Fund.
Further, U.S. GDP growth is boosting the performance of these types of companies, he adds. In “the third quarter [of 2014], we saw the highest [GDP] growth level since 2003. Estimates for Q4 2014 are a little lower than expected,” but he predicts the U.S. will continue to outpace other global economies.
“This growth reflects, in part, an upturn in consumer spending,” says Hollond. And, “when you add the precipitous drop in gasoline prices, you get a positive environment for consumers.”
Winner & losers of specialty retail
Two types of U.S. specialty retail stores that are benefiting from the growing economy are home centres and auto part retailers. The latter group includes companies such as Tennessee-based AutoZone, Missouri-based O’Reilly Auto Parts and Virginia-based Advanced Auto Parts.
“When gas prices fall, people drive more,” explains Hollond. “And as miles driven go up, cars [typically] need more repairs due to increased wear and tear.”
Top-performing home centres include international retailers such as Lowe’s and Home Depot. They’re “seeing continued strong growth, and the biggest driver of their growth is U.S. GDP. Plus, the improvement of the housing market has resulted in more turnover, and that’s a key driver of sales for home centres.”
For retailers, says Hollond, one metric he looks at is acceleration of same-store sales. “Sales can be driven by higher traffic or by what we call ‘higher average ticket,’ which means each shopper is spending more, on average, than in the past. What we also like to see is companies that have strong gross margins since that means the sales they’re making are increasingly profitable.”
He adds, “Some companies can show you nice sales growth, but that’s because they’ve discounted and practically given away all of the products in their store[s]. We don’t want unprofitable discounting so looking at improving, or strong, gross margins is a way to make sure that’s not happening.”
Regarding Lowe’s, Hollond says the chain “has seen accelerating same-store sales growing 5% year-over-year” as of Q3 2014. That compares to a little more than 4% in Q2 2014 and only about 1% in Q1 2014.
Delving deeper, Hollond finds Lowe’s also “saw acceleration throughout the third quarter [of 2014], with August up 3.5%, September up 5% and October up almost 7%.” That indicates improvement throughout the year, as well as throughout individual quarters.
Rather than focus on the history of companies, says Hollond, “it’s important [for investors] to focus on specialty retail names that are getting the most out of the current economic environment.”
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