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Best, And Worst, Of Times For High-End Retail

Posted: Aug 29, 2008 16:34 PM by Stephen Simpson

Tickers in this Article: ARO, AEO, TGT, WMT, JWN, WSM, ZLC, TIF

Charles Dickens would appreciate this sort of market, as it seems to be either the best of times or the worst of times depending upon which retailer you're checking out. While it makes sense that a discount retailer like Wal-Mart (NYSE:WMT) would be doing well, its rival Target (NYSE:TGT) isn't getting the same Wall Street love. Ditto American Eagle (NYSE:AEO) and Aeropostale (NYSE:ARO) - both have similar target markets and are of similar size, but have seen dramatically different stock performance over the past year. (Learn to looker deeper into companies such as these in our related article Analyzing Retail Stocks.)

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But what's going on with the higher-end merchandise? Let's take a look.

Tiffany (NYSE:TIF)
This high-end jeweler gave its investors a gift-wrapped announcement Thursday, as earnings for the second quarter handily beat estimates and management was fairly optimistic about the near-term future.

However, look past the 11% stock jump and there are some smudges on the jewels. Same-store sales are still growing, but the momentum appears to be slowing. What's more, with the pronounced weakness in the financial services sector, the prognosis for the flagship New York store could be better.

But like the aforementioned smudged jewels, there's some solid value underneath. Tiffany doesn't promote itself through sales (so there's no real mark-down risk), the high-end jewelry market is still fragmented, and the balance sheet is in solid shape. What's more, there aren't too many better-known brands in the retail world than Tiffany.

Zale (NYSE:ZLC)
Admittedly, Zale is a bit of a cheat. The company isn't a high-end brand like Tiffany, but it does sell goods that are best described as "luxuries". Like Tiffany, the company sparkled as it announced that it had lost a fair bit less money for the recent quarter and likewise raised guidance. (Explore the controversies surrounding companies commenting on their forward-looking expectations in Can Earnings Guidance Accurately Predict The Future?) Unlike Tiffany, Zale is still in a position where the hopes and expectations of investors center around "less bad" than "good". Zale had been struggling for years with unsuccessful restructuring efforts and management turnover, but things seem to be finally falling into place. The market has certainly taken notice, as the stock took a sharp turn at the beginning of the year and has roughly doubled since then.

At long last, maybe this company has gotten it back together - management seems to be on to something with lower inventories and spruced up stores. Unfortunately, this doesn't look like the best time to buy into this turnaround story. The stock price has already bounced strongly, mall traffic doesn't seem to be getting better, and it's difficult to foresee a lot of spending on non-essentials if the economy gets any tougher.

Williams-Sonoma (NYSE:WSM)
On the flip side, Williams-Sonoma shareholders were left hoping that they could take these shares back to the store. In a mirror image of the two jewelers, this well-known housewares retailer missed the quarter by a wide margin and cut guidance sharply.

It's tough to find good things to say about the current state of business here. Same-store comps were bad (and got worse during the quarter), margins were lower, and there really isn't much to suggest that a quick turnaround is in the offing. To that end, management did discuss plans during its conference call to slow the growth in square footage and capex spending.

That's not to say, though, that Williams-Sonoma doesn't merit a spot on a watchlist. The company has a history of producing solid returns on capital and has successfully launched multiple brand concepts. Those are both solid metrics of management skill, and it doesn't look like there are problems here that a better economy couldn't help.

Nordstrom (NYSE:JWN)
In the middle of it all is Nordstrom. This company's second quarter (reported on August 14) was lukewarm at best. Same-store sales were weak (down 6%) and gross margins were down, but SG&A expenses fell and inventory per square foot was down over 9%. That's not a good quarter - nor is it devastatingly poor. Nordstrom shares don't look too pricey and this company has a near-legendary reputation for customer service; a reputation that should keep returns firm and customers coming back in the future.

Reacting To Retail
Given the uncertainty in the markets, perhaps it should be surprising that there's a dichotomy even in the higher end. Nevertheless, investors would do well to exercise caution until there's a little more clarity on whether we're in a slow business cycle or a potentially nasty recession. What could look to be the best of times for your portfolio, could unravel to the worst of times in a few short months.

By Stephen Simpson

Stephen Simpson, CFA, has worked as an equity analyst for both sell-side and buy-side investment companies, and presently works as a sell-side equity research analyst. He has worked as a consultant for the healthcare sector, and has written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson is the editor of Kratisto Investing, a website devoted to financial analysis and personal commentary.

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