It has been a tough few months for short-sellers of retail stocks. Buyout activity has helped buoy stock prices in the sector until Tuesday when it took a turn, and retail stocks were bathed in red following profit warnings from Sears and Home Depot.
The rumor mill has artificially inflated the prices of many retail stocks, according to analysts. What's worse, there could be further downside ahead.
Retailers are climbing a wall of worry with declines in mall traffic, higher gas prices and housing market concerns putting pressure on consumers.
Target is one retailer whose share price has benefited from the market chatter. The retail rumor mill was abuzz this week with speculation that activist investor Bill Ackman was putting pressure on the company to spin off its credit card division. Neither Target nor Ackman will comment on the possibility of a sale.
Still, Target shares rose to $68 from $63 a share despite the skepticism of analysts like Citigroup’s Deb Weinswig who says that while a divestiture of Target’s credit card business could expand the stock’s PE multiple, she thinks that a sale is unlikely. While the rumor has not been substantiated, the possibility of sale has boosted Target's share price by about $7.
JP Morgan analyst Charles Grom has an "overweight" rating on Target shares, but due to the recent runup he is recommending investors take profits now. This is partly due to the fact that the company has guided its June same-store sales to come in at the low end of the 3% to 5% range.
“The stock had a nice run on the credit card rumor so it is probably long in the tooth in the $65 to $70 range,” Grom said.
He also thinks Macy’s and BJ’s Wholesale have benefited from the retail rumor mill.
Grom expects BJ’s CEO is dressing up the company for sale this year or early next year. However, he said Macy’s is unlikely to become an LBO target.
Meanwhile, Weinswig said a leveraged buyout of Macy’s is “possible, but not probable.”
The company has not commented on the rumors that Sears Holdings Chairman Eddie Lampert may try to acquire Macy’s, but the share price has climbed the past three Fridays on speculation that it is a target. That boost is countering negative pressure from Macy’s own weak same-store sales reports.
These individual buyout stories also lift the share prices of retailers within similar categories.
When department store valuations are compared to those of dollar stores, there is a clear premium among the dollar store stocks that can be traced to KKR’s buyout of Dollar General in March, Grom said. Right now, department store stocks are trading at 13 times forward price-to-earnings multiples, while the dollar stores are trading at multiples in the 18 to 19 range.
“That delta doesn’t make a lot of sense to me in terms of longer term fundamentals,” Grom said.
So how do investors manage to separate the rumors from the reality of retail sector health? Grom suggests being short stocks in the sector as a near-term trade.
Still, trading volatile retail stocks is not so simple. The make-or-break underlying fundamentals that influence consumer spending -- such as employment -- are strong. Over the next four to six weeks, the retail picture may start to look more rosy as back-to-school orders are released.