Walmart Wreaked Havoc on Retail. Grab These Unfairly Punished Stocks Now.

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You know retail is in trouble when even

Walmart

can’t manage its way through inflation pressures. Still, some stocks are starting to look appealing despite the headwinds.

On Monday night, Walmart (ticker: WMT) became the latest retailer to warn that shoppers are being forced to spend more on food and other necessities and they’re making sacrifices by cutting back on clothes and other discretionary items. Its stock dropped 7.6% on Tuesday, and its warning was so dire it sank the entire retail sector, with the

SPDR S&P Retail exchange-traded fund
(XRT) slumping 4.2%. The shares of companies focused on lower-income shoppers, who seem to have been particularly hard hit by rising inflation, were among the hardest hit.

“Walmart’s announcement is confirmation that the low-income consumer is extremely distressed …and that distress is starting to become a middle-income phenomenon,” says John San Marco, portfolio manager at Neuberger Berman’s Next Generation Connect Consumer ETF. “My strong suspicion is that when we get through this retail earnings season, Walmart is not going to look uniquely bad.”

Bargain hunters are rightfully wary. The companies’ size means that their pain—and their necessary discounting—will reverberate throughout the industry. Citigroup presciently warned in June that regardless of the broader economy, it was going to feel like a recession in apparel, and Jefferies analyst Stephanie Wissink said much the same on the heels of Walmart’s announcement: “While the headlines suggest we aren’t in a recession, we appear to be firmly in a ‘discretionary goods recession.’”

Not all goods are created equal though. Companies that sell relatively basic apparel, like Walmart and Target, are undoubtedly feeling the pain. That’s evident in retailers like Gap (GPS), which recently ousted its CEO as it too cut its margin outlook. Yet the situation may not be as dire as some fear. Walmart did say it’s made progress working through inventory, gas prices have come down in recent weeks, and spending doesn’t appear poised to fall off a cliff.

Stifel analyst Mark Astrachan notes that Walmart’s update is likely more “backward looking,” given his firm’s recent survey mid-July data that show “weakening spending intentions amongst the lowest earners bottomed in late-June …[and] spending intentions sequentially improved across all income levels.” That doesn’t mean spending might not shrivel later this year, but for the second quarter at least he thinks retailers should at least be able to meet lowered expectations.

Even companies that should be able to manage well were hit hard in Tuesday’s selloff.

Costco Wholesale

(COST) fell 3.3% even though it does well when shoppers seek out value.

Tractor Supply
Co.
(TSCO) slumped 5.3% even though it delivered a beat-and-raise quarter earlier this week. Auto parts stocks are not only fairly countercyclical, but enjoy decent pricing power. Still,

AutoZone

(AZO) dropped 2.2% and

Advance Auto Parts

fell 3.6%.

But what about apparel retailers themselves? Much as forward outlooks dominated first-quarter post-earnings performance for retailers, margins may be one of a few key areas of focus for the coming second-quarter earnings season.

The reality is that from Gap to

Bath & Body Works

(BBWI) many retailers are giving back much or all of the progress they made on margins during the pandemic; in fact, margin contraction is widespread, writes DataTrek Research co-founder Nicholas Colas, as energy and industrials are the only two of the S&P 500’s 11 sectors expected to show year-over-year improvement in the second quarter, according to FactSet’s consensus estimates.

But not all retailers should feel the squeeze.

Levi Strauss

& Co. (LEVI) may be one retailer unfairly pummeled: It’s hard to find much appeal in casual clothing sellers right now, and it faces risk from greater overall discounting in the space. But the company’s margins held flat in its fiscal second quarter, which was reported less than three weeks ago, meaning its more upbeat trends reflect more recent data.

TJX

Cos. (TJX) also looks attractive, benefiting not only from strapped consumers trading down, but a glut of inventory to choose from. “TJX is uniquely positioned, even more so than other off-pricers, to capitalize on the retail carnage, as better brands and vendors are going to approach them with attractive deals on merchandise,” says San Marco, who also likes its strong customer loyalty.

And what to do with Walmart itself? Some hoped Target’s second forecast cut would be a low-water mark for that stock, but that clearly hasn’t been the case. With retail earnings season around the corner, it’s hard to argue that Walmart has bottomed here.

Yet it does have one advantage: At a time when management teams have been particularly flat footed in response to a rapidly changing consumer, Walmart does at least have a new Chief Financial Officer, John Rainey, who oversaw a period of great stock performance at

PayPal

(PYPL).

Perhaps he still has the magic touch.

Write to Teresa Rivas at [email protected]