Farrell: Retailers?

Last week consumer credit for the month of September was reported and fell by -$14.8 billion. That marked the eighth consecutive month the consumer pulled in his/her horns. Consumers apparently continue to believe they are too highly leveraged and are working to pay down debt. Banks are still tightening lending available to consumers (and small businesses) and are even pulling existing credit lines from established customers. It is not possible to tell from the data if the drop in credit outstanding came from consumers cutting back willingly or from credit being withdrawn. But it may not matter since a drop in credit for whatever reason means lower total consumer spending.

Consumer debt as a percent of income is lower than just a few months ago but still way above normal. It peaked at something like 136% of income and is now closer to 125%. But the long term average is closer to 93% and things usually revert to the norm. This is not an environment to normally poke around retail stocks.

But Jeff Stein of Soleil/Stein Research has indentified a few value added retailers that offer the consumer a better deal than many others. We have noted JoAnn Stores before. Jeff had additional comments Tuesday on the company. The latest data point in the craft industry (roughly 50% of JAS sales) suggests JAS is continuing to gain market share. Last week A.C Moore reported comp store sales for the third quarter were down -7.7%. JAS had a gain of better than 4% for the same period . JoAnn Stores has been the beneficiary of Wal-Mart's gradual withdrawal from the fabric business but Jeff thinks "the much greater opportunity will fall on the craft side of the business". JAS has an estimated 20% share of the $5 billion fabric business but only 4% of the approximately $25 billion craft business. Around 40% of craft sales are independent retailers that may not have committed credit lines and could well be suffering cash flow problems. JAS has a strong balance sheet and should finish the fiscal year with about $100 million in cash net of debt. Jeff's target is $42.

Lakruwan Wanniarachchi | AFP | Getty Images

TJX Companies is another of the value focused retailers. You should never rely on the anecdotal but my granddaughter, Lola Jane, now three, and I went to the local TJ Maxx store to buy "special" pajamas for a three year old and couldn't find a parking spot! I did also notice far nicer cars than mine in the lot. Value based shopping is definitely the in thing. Jeff has raised his estimates for the company to $2.54 for fiscal 2009 and $2.85 for fiscal 2010. At the current price of $39 the stock sells for 13.7 times the Jan 2010 year.

The company has several brand names with the Mar/Maxx division, which encompasses the well known TJ Maxx and Marshall's, accounting for 65% of sales and almost 75% of operating profit. October comp store sales were up an impressive 10% and the company has had only one negative comp year since 1982. On the vendor side "tough times force vendors to seek out alternative channels of distribution because traditional customers close stores, go out of business, or pare back inventory levels". In good times "retailers increase inventory levels, add new vendors and take more risks, increasing the close out opportunities for TJX even more".

For the consumer side, rising unemployment, high debt levels and reduced wealth has forced consumers to save more, forcing households to stretch their budgets. TJX has been one of the solutions to the consumer quandary. Jeff writes "Consumer traffic has been up in stores all year, while the vast majority of the industry has posted negative traffic trends".

Remarkably, during a challenging year for all businesses, and despite spending $600 million buying back stock, the company improved its balance sheet significantly the last twelve months. In January of 2009 TJX had $750 million in debt and $450 million in cash. Jeff figures that by January of 2010 cash will be $413 million and debt $375 million. Jeff has a $45 price target which would be 16.1 times fiscal 2011 earnings and 7.8 times FY 2011 EV/EBITDA. Both are in line with historic averages. Reports on JAS and TJX are available through your Soleil salesperson.

Vincent Farrell, Jr. is chief investment officer at Soleil Securities Group and a regular contributor to CNBC.