Retail Stocks Got an Earnings Boost. Why There’s No Comfort in That.

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Investors breathed a sigh of relief as retail earnings season ended this past week. Perhaps they should still be holding their breath.

From

Walmart

(ticker: WMT) to

Best Buy

(BBY) to

Gap

(GPS), many retailers’ stocks got a boost from quarterly reports in August. The market was quick to cheer companies able to churn out better-than-expected results, despite selling products that had fallen out of favor with shoppers.

One thing these companies share is that they cleared a bar they had lowered just weeks before. Many retailers are still struggling with the high inventories that caused so much damage in the first place, with profits dragged down by pricier supply-chain and transport costs. That isn’t a great position to be in when high inflation is eating into Americans’ savings, threatening to tamp down consumer spending.

“Big picture, we see a demand-driven recession later this year or early next year,” says Chris Senyek, chief investment strategist at Wolfe Research. “Consumers are just running out of steam.”

You wouldn’t know that from looking at retail stocks. In August, the

SPDR S&P Retail
exchange-traded fund (XRT) was off just 0.3%, outperforming the

Consumer Discretionary Select Sector SPDR
ETF (XLY), which dropped 4.5%, and the

S&P 500,
which was off 4.2%.

That should be taken as a sign that investors had braced for the worst, not that everything is fine. Take Best Buy. It reported a profit of $1.54 a share, beating expectations by 27 cents, even as sales at stores open for at least 13 months fell more than 12%. Still, while that was good enough for the stock to gain 1.6% on Tuesday, not even the bulls were thrilled.

“The best that can be said about Best Buy’s results is that they were no worse than expected, which for retail names, has been good enough this summer,” says D.A. Davidson analyst Michael Baker, who has a Buy rating on the stock.

For investors wary of getting caught in the next retail drawdown, inventories might be the key metric to watch, says Senyek. That’s particularly true because it’s likely that retailers have overordered, not only for the quarter just ended, but perhaps into year end. “Inventories don’t lie,” Baker adds. “We could see a double whammy through the holiday season as demand slows.”

His research points to a number of discretionary stocks that have seen inventory outstanding climb meaningfully, quarter over quarter and year over year. The top 10 span the income spectrum:

Columbia Sportswear

(COLM),

VF
Corp
(VFC),

Kohl’s

(KSS),

Deckers Outdoor

(DECK),

Capri Holdings

(CPRI),

Carter’s

(CRI),

Ralph Lauren

(RL),

Ollie’s Bargain Outlet

(OLLI),

Hanesbrands

(HBI), and

Five Below

(FIVE).

One company in the screen stood out, the only one with triple-digit increases quarter over quarter and year on year—and it wasn’t a retailer.

Universal Display
’s
(OLED) inventory was up by 113 and 158 days, respectively, partly because display companies historically hold more inventory than other companies. But it also speaks to the fact that the consumer demand slowdown goes beyond T-shirts left on the rack at Gap and affects Universal Display’s end markets, from tablets to TVs. “It’s not terribly different at a high level than what’s happening in retail,” notes Senyek.

Summer’s lease is all too short, and for retail stocks, August’s reprieve could fade, along with the season.

Write to Teresa Rivas at [email protected]