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5 Retail Sector Bargains to Buy Before 2013

Stuart O'Sullivan | Stone | Getty Images

Buyers are coming out in droves right now. No, I'm not talking about stock buyers for a change; I'm talking about retail.

As consumers check boxes off of their Christmas lists, retail stocks are getting buoyed by materially higher sales. Even though economic black clouds are getting most of the attention in December, retail sales are growing fast this holiday season. The National Retail Federation is expecting holiday sales to increase by 4.1 percent when all of the receipts are tallied up at the end of the year — and that's on top of actual growth of 5.6 percent in 2011.

That's not to say that investors have ignored retail stocks in 2012. In fact, the sector has shown serious relative strength versus the S&P 500, outperforming the broad market as household name stocks post bigger profits.

But some retailers have benefitted more than others.

And some surprising names are looking like bargains compared to the rest of the retail herd right now. That's why we're taking a look at the bargain names today.

With technicals for the retail sector in whole looking strong, this bargain bin is comprised of the other half of the coin — fundamental valuation metrics that come in cheaper than their sector averages. In particular, we're focusing on firms who are earning more profits, bigger cash flows, and sport better book values for each dollar of share price they're trading for right now.

Here's everything you need to know about five retail sector bargains worth buying before 2013.

Costco Wholesale

At first glance, Costco doesn't look like much of a bargain: the firm trades for around 24 times earnings, and shares are around 20 percent more expensive today than they were on January 1. But you can't look at stocks like Costco in a vacuum — relative to the numbers in the rest of the sector, Costco is currently trading for a bargain. And given the strong trajectory of this stock right now, that's a big deal for investors who've been thinking about picking up a position in this stock.

Costco is the league leader in the members-only warehouse store model. While the firm's 430 stores worldwide fall short of the numbers seen at Wal-Mart Stores unit Sam's Club, Costco makes more money. In fact, with big-ticket items buoying Costco's check-out lines, the firm's sales per square foot come in at nearly twice what its biggest rivals turn out. The membership model is extremely attractive for Costco shareholders and customers — it enables the firm to offer paper-thin margins on the products it sells, but still earn significant net income from membership fees. And since consumers are less likely to carry memberships from competing wholesale clubs, Costco's existing base of higher-spending customers gives the firm a shallow economic moat versus its peers.

Financially, Costco is in stellar shape, with $5.6 billion in cash offsetting a paltry $1.4 billion debt load. Revenues have been climbing in stair-step mode over the last several years, and the recession barely registers as a blip for the firm. That combination of financial wherewithal and growth make Costco a good option for investors looking for a stalwart retail name.

Ralph Lauren

In the apparel business, brand matters. That's why Ralph Lauren's recognizable label has help to build the firm into a $14 billion retail behemoth. Obviously, retail isn't Ralph Lauren's sole market — the firm's several hundred retail stores are dwarfed by 11,000 third-party retailers that sell Ralph Lauren products. But because this stock sports a sector discount, and because retail is key to Ralph Lauren's growth strategy, the firm makes our list.

Retail matters for Ralph Lauren because it's the key to pricing power. While Ralph Lauren needs exposure in department stores to keep its sales volume high, the firm can extract comparatively huge margins through its full-price stores around the world. International exposure is a big deal for Ralph Lauren too; because the firm is a recognizable luxury apparel brand the world over, it's seen as an easily attainable status symbol for burgeoning middle class populations in emerging markets. That's why adding onto the firm's 100 full-price stores overseas should continue to be an extremely effective use of capital in 2013.

Like Costco, Ralph Lauren is in excellent financial shape. The firm's $266 million debt load is offset by more than $1.1 billion of cash and investments on its balance sheet, giving Ralph Lauren plenty of liquidity to handle any unforeseen hiccups in the economy. And with shares trading for a double-digit discount to the rest of the industry, there's also plenty of upside potential in this stock right now.

Lowe's Cos.

Shareholders of home improvement retailer Lowe's Companies are pretty happy in 2012 — their stock has appreciated by more than 41 percent since the first trading day in January. Despite that rally in Lowe's, this stock is looking like a bargain compared to the rest of the sector: it trades for a 20 percent discount to P/E, a 37-percent discount to its cash flow multiple, and a 17-percent discount to its book value per share.

Lowe's is one half of the home improvement duopoly in the North America, with around 1,750 stores spread throughout the U.S., Canada, and Mexico. As housing has started reheating and home builders have rallied exceptionally hard, Lowe's has been able to pick up some of that momentum for itself. When sales growth languished during the Great Recession, Lowe's focused on internal efficiency, improving merchandising and distribution to squeeze bigger margins out of the revenues it was earning.

Until top rival Home Depot's "rip-off-the-bandage" approach to restructuring, Lowe's was far and away the better home improvement retailer operationally. Now, with Lowe's taking on its own restructuring plan (albeit a less desperate one), investors should expect similar operating metrics from this firm. Lowe's balance sheet is a little more conventional for a retailer: it carries a decent amount of leverage (used to build out stores), and a modest cash load. That said, cash easily covers debt obligations, and the firm still has access to dry powder if it needs it. The increased focus on store brands should keep boosting net margins for Lowe's in 2013.

Limited Brands

Limited Brands is a staple in U.S. malls this holiday season. The firm owns a portfolio of popular retail store concepts that include Victoria's Secret, Bath & Body Works, and White Barn Candle, high margin stores that see considerable traffic.

Victoria's Secret is Limited's crown jewel. The store chain has a strong brand with celebrity exposure, it operates in the extremely high margin lingerie business, and it sports an economic moat for its trouble. Victoria's Secret should continue to be a prototypical brand as Limited looks to expand its offerings with new store concepts. The decision to sell off the namesake Limited store chain was a big message that Limited management is less concerned with convention than they are with performance — investors should be very happy about that.

It doesn't hurt that management and investors are one in the same. Founder Leslie Wexner and his wife Abigail own a massive chunk of outstanding shares, keeping incentives skewed towards owners over than management. With Limited trading at a substantial discount to the rest of the sector right now, this stock looks like a solid retail opportunity this month...

Bed Bath & Beyond

Last up is Bed Bath & Beyond, another name that's trading at a considerable discount to the retail sector as a whole right now. Bed Bath & Beyond spent most of the last two years rallying, only to get a couple of major price haircuts earlier this year on guidance updates. While those declines were rough, they also over-corrected for the multi-year climb that shares had been enjoying. As a result, this stock looks like a bargain with a price-to-earnings ratio of 13 — and a forward P/E that's teetering on the edge of single digits.

Bed Bath & Beyond's namesake housewares stores sport a nice balance between luxury spending on kegerators and massage chairs and non-discretionary spending on sheets, pots, and pans. Newer store concepts like Buy Buy Baby and Christmas Tree Shops are expanding the firm's core focus, and they provide one of the biggest opportunities for top line expansion right now.

One of the most impressive things about Bed Bath & Beyond is the fact that it's managed to build its 1,000-store empire with no debt. Instead, the firm has historically used its own cash to build new stores, a strategy that avoided the super-expansionary downfall of many rivals during the recession and left the company with a spotless balance sheet. As a result, Bed Bath & Beyond has the ability to generate a mountain of cash just by cutting down on capital expenses for a while. That cash machine should help cut any concerns that investors have about this stock's next rally leg. (Read More: Bulls Look for Rally in Bed Bath & Beyond)

—By TheStreet.com Contributor Jonas Elmerraji

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Disclosure: At the time of publication, Jonas Elmerraji had no positions in stocks mentioned.