The Pandemic Made These Retailers Stronger. Their Stocks Are Buying Opportunities.

“We’re in a babies-and-bathwater situation,” says BMO Capital Markets senior analyst Simeon Siegel, noting that retail names have sold off fairly indiscriminately. “We need to differentiate between Covid winners and those that simply won during Covid,” he says. “We’re looking for the companies for which Covid provided a fantastic distraction that allowed them to refashion and revitalize their business.”

It isn’t hard to see why investors have soured on retail. Inflation is driving up labor costs at the same time that high prices are crimping customers’ wallets, and companies across the board are dealing with margin-crunching supply-chain headaches.

This couldn’t come at a worse time, as year-ago comparisons will be especially difficult in the second quarter, given the timing of the last round of stimulus in mid-March of 2021.

No wonder, then, that investors have avoided the sector, and retail stocks seem poised for a difficult few months. Geopolitical worries and inflation continue to dominate the headlines at the same time that pent-up demand is driving people to spend more on cruises and cocktails than at the mall.

Yet it isn’t all bad news. The biggest retail players generally projected a bright outlook in terms of consumer spending during the most recent earnings season. Even more encouraging was the broad-based nature of that commentary: From big-box stores to specialty retailers, companies across the income spectrum sounded positive.

Discounters like

Dollar General (ticker: DG) and

Walmart (WMT), midrange players

Macy’s (M) and

Target (TGT), and more-premium names including

Nordstrom (JWN),

Nike (NKE), and

Williams-Sonoma (WSM) were all relatively upbeat about the year to come.

At Nike, for instance, worries about ongoing sluggishness in its China business and general consumer demand have hurt the stock, which has fallen more than 20% year to date and trades at under 28 times forward earnings, below its five-year average of more than 30 times.

Even so, on average, analysts predict Nike earnings per share to reach records this year and next, with sales jumping above the $50 billion mark in 2023 for the first time.

Chuck Grom, an analyst at Gordon Haskett, says that the next couple of months will be tough for retail, but “if we get through that without a ton of [valuation] compression, that bodes well for the rest of the year.”

There is no doubt that even strong players will see some choppy sales data around the anniversary of the stimulus and the start of the summer, while supply-chain issues remain problematic. Yet the continuing strength of the consumer, the uptick in wages, and a less-worse-than-feared tone from the sector could all point to a stronger second half of the year.

That said, some retailers will struggle, and it pays to be choosy. Perhaps one of the best strategies is to seek out companies that used the pandemic to their advantage, making ambitious structural changes to how they do business. Companies that have transformed or are in the midst of a turnaround are better adapted to the new retail landscape. Success can translate to earnings power above the industry average.

“I like to think about the fable of the three little pigs,” says Burns McKinney, senior portfolio manager at

NFJ Investment Group. “If the third pig learned and made his house out of brick, now there’s a fourth pig, one that’s making his house out of bricks-and-mortar and e-commerce.”

E-commerce is, of course, nothing new. But companies’ use of it has changed. Instead of just using an

Amazon.com-like model to sell goods via their websites, retailers are using their online presence to build their brand and provide omnichannel options, while turning physical locations into showrooms and distribution centers.

“The store comes to you, just as you can come to the store,” says Dana Telsey, CEO and chief research officer of Telsey Advisory Group, about the major shifts that retailers have made in fulfillment. “Companies’ balance sheets are strengthened, and they know more about their customers through data—they’re capturing new customers and getting more out of existing customers. Some companies are healthier today than they would have been without the pandemic.”

There are stocks across the sector that have a strong self-help component, which could put them in a better position as the tide recedes.

Nordstrom is a stock that Barron’s has highlighted previously, and it’s one of our favorite stocks for 2022. Although the shares are already up more than 25% year to date, the outlook is very upbeat. The company’s omnichannel capabilities and customer service, already best in class, proved to be even more valuable during the pandemic. The department-store space may no longer look like it did a decade ago, but Nordstrom is poised to do well in the new normal.

Despite its gains, Nordstrom’s stock—which trades for under 8.8 times forward earnings—still looks cheap, as we noted back in January. It sports a 2.6% yield and has one of the highest returns on equity of its group, above 40%. Analysts expect the company’s earnings per share to more than double this fiscal year, to $3.16, on a 5% increase in sales, to $15.58 billion.

If department stores have been shrinking, big-box stores have done just the opposite. Walmart and Target may have gotten an initial boost from being essential retailers, but they have done far more than ride that wave. Walmart has expanded rapidly in areas as varied as healthcare to finance, and now generates billions from advertising, as well.

Likewise, Target has gone from strength to strength, and its customers are sticking with pandemic innovations like curbside pickup as the company continues to bring down fulfillment costs.

Both look able to continue gobbling up market share, although Target, at 15.5 times forward earnings, is the cheaper of the two and has a higher return on equity—above 50%—after several years of rapid expansion.

Analysts predict that Target’s earnings per share will climb 7.3%, to $14.55, on a 3.5% increase in sales, to $109.7 billion, this fiscal year, slightly ahead of Walmart’s growth rate. Target’s 1.5% dividend yield is the same as Walmart’s.

Other discounters also look well positioned, given their focus on value at a time when consumers are facing higher costs. Dollar General is a longtime Barron’s pick that struck an upbeat tone about the full year. It has also transformed itself, with initiatives ranging from fresh produce to its partnership with

DoorDash and international expansion.

A more value-focused consumer also helps

Dollar Tree (DLTR), which has the added benefit of a revamped board and the recent successful rollout of higher-priced merchandise.

Both shares trade around an undemanding 20 times forward earnings, and Dollar General’s earnings per share look poised to climb 12.6% this fiscal year, despite tough comparisons, to $11.45, as sales increase more than 9%, to $37.37 billion. Analysts are looking for Dollar Tree’s earnings per share to jump 37%, to $7.97, on sales that are projected to rise more than 6%, to $27.93 billion.

Lowe’s (LOW) improvement story has continued to help the retailer dispel worries about difficult comparisons. While industry leader

Home Depot (HD) has its own catalysts, Lowe’s ability to play catch-up should help it continue to post strong numbers, even as consumers’ worlds once again expand beyond their homes.

While both companies will see their same-store sales inevitably slow from the white-hot levels notched during the pandemic, analysts expect they’ll avoid dipping into negative territory.

The consensus calls for Lowe’s earnings to rise nearly 13% this fiscal year, to $13.47, on a 2.1% increase in sales, to $98.30 billion. That’s a faster clip for bottom-line growth than Home Depot, while Lowe’s trades more cheaply, at 14.9 times forward earnings.

It’s worth noting that all of the retailers above, save Nordstrom, are expected to post record earnings per share this fiscal year, despite industry headwinds.

In all, the outlook for retail might not be as sunny as it was last year, but people have continued to spend. To hark back to another fable, retailers that followed the example of the industrious ant look better able to capture postpandemic dollars than the grasshoppers that just basked in the glow.

“There are a lot of reasons for optimism, but there’s also room for stock selection,” says McKinney.

Write to Teresa Rivas at [email protected]