It will be a few weeks until the final numbers are in, but the 2018 holiday shopping season is shaping up to be the best one for the retailing industry in many years. Yet the bigger returns for investors come from finding companies that can perform well -- whether or not the industry as a whole is growing robustly.
With that in mind, we asked Motley Fool contributors to highlight some attractive retail stocks heading into 2019. Read on to see why Target (NYSE: TGT), Costco (NASDAQ: COST), and Abercrombie & Fitch (NYSE: ANF) topped that list.
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Target is too cheap to ignore
Jamal Carnette, CFA (Target): Last year, I predicted 2018 would be a great year for Target's stock based on low valuations, improved profitability due to the then-recently enacted tax law and an improving economy, and moderate improvements in operations, particularly digital sales. This thesis played out, with shares rallying approximately 30% through November, but they have given up all gains as a part of the greater retail sell-off and a bottom-line miss in the third quarter.
Despite the sell-off, most of this thesis is intact: Target has continued to improve sales via its digital channel, growing from 28% year-on-year growth in the first quarter to 45% in the recently reported third quarter; increased full-year guidance on comparable sales and EPS; and increased its dividend per share by 3.2%, marking its 47th consecutive year of dividend increases. I'm less worried about the third quarter, as margins were impacted by increased shipping costs and an increase in inventory for the holiday season.
Due to the sell-off, shares are cheap again. Target trades at approximately 11.5 times forward earnings versus the overall S&P's valuation of 15 times, and shares yield 4.2% versus the overall 2.1% S&P 500 yield. I'm expecting a strong fourth quarter for Target, and income-hungry value investors should take advantage of Wall Street's temporary bearishness.
Costco just keeps winning
Demitri Kalogeropoulos (Costco): Many retailers are enjoying growth levels that they haven't seen in years right now, but warehouse giant Costco is taking that outperformance to a new level. Sales jumped 8% in the most recent quarter, after adjusting for new store openings and foreign exchange rate shifts, to surpass comparable metrics from Walmart and Target. Costco's spike of more than 5% in customer traffic also beat these peers and constitutes an incredible growth number for a company that does more than $140 billion of revenue per year.
Investors seem to be more concerned about negative trends that could combine to weaken earnings growth in 2019. First, the initial profit benefit from Costco's subscriber fee increase is winding down. And second, the company is facing rising costs on many of its products thanks to inflation and increasing tariffs.
Those are short-term worries, though, that don't say anything about Costco's enduring value proposition. For a useful approximation of that asset, investors just need to check its membership renewal rate. At nearly 91%, that metric is approaching an all-time high, which suggests Costco is having no trouble delivering value to its increasingly loyal shopper base. That success should help power market-beating earnings long after the latest cost spikes subside.
A reborn apparel retailer
Leo Sun (Abercrombie & Fitch): Abercrombie & Fitch seemed like a lost cause three years ago as its controversial CEO resigned, sales and profits tumbled, and fast-fashion rivals lured away its core shoppers. But over the past year, CEO Fran Horowitz -- who took the helm in early 2017 -- saved the retailer with four main strategies.
First, A&F turned on the lights at its dark and cologne-scented stores, renovated them, and launched inclusive marketing campaigns that dumped the shirtless models who had dominated its ads in previous years. Second, A&F focused on turning its higher-growth Hollister brand into its core growth driver and streamlining A&F as its smaller secondary brand.
A&F also reduced its brick-and-mortar footprint and expanded its e-commerce presence with new social media campaigns. Last, it expanded more aggressively into higher-growth overseas markets like China. All these strategies enabled A&F to report five straight quarters of positive comps growth with stable gross margins -- which indicates that it isn't using markdowns to boost sales.
A&F's comps rose 3% last quarter, beating expectations of 1.6%, with 4% growth at Hollister and 1% growth at Abercrombie. It expects its full-year sales to rise 2% to 4% and its gross margin to expand slightly, and analysts expect its earnings to improve 45%.
Analysts expect A&F's revenue and earnings to rise 2% and 18%, respectively, next year. Those are solid growth rates for stock that trades at 17 times forward earnings and pays a forward dividend yield of 4.3%.
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Demitrios Kalogeropoulos owns shares of Costco Wholesale. Jamal Carnette, CFA owns shares of Target. Leo Sun has no position in any of the stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool has a disclosure policy.