North American markets today, Friday, viewed several hours before the 9:30 a.m. EST opening appear set to start strong with major indicators all in the green. The S&P 500 looks slightly weak but appears likely to remain positive and improve by market opening. The safe havens of gold and silver are mixed, with gold up and silver down. Currencies are also mixed with the British pound sterling and Euro up and the Canadian dollar down. This morning’s jobs report – a major barometer of the status of the recovery -- is likely to show large gains following the increase of 916,000 in March.
Meanwhile, as we try to assess the recovery, investors and their advisors have a huge number of investment decisions to consider. One of them is exposure to the retail sector and the best investments within it.
It’s a complex sector with serious questions, some of them troubling. The bankruptcies of such retail icons as Hertz Global Holdings Inc., J.C. Penney, Neiman Marcus Group Inc. and others might add to an investor’s nervousness.
Some of the obvious big-name possibilities look a little pricey at this time. Amazon.com is currently trading at over 60x forward earnings, according to Thomson One. This calls for caution according to Jay Nash, Senior Vice President, Portfolio Manager and Investment Advisor at National Bank Financial in London. “We’ve been here before….and there will be those whose ultimate defense is ‘This time it’s different.’ I don’t believe that it’s ever different,” he says.
The S&P 500 currently trades over 22x forward earnings while the 30-year average trades at about 16.5x. Either the companies in the S&P 500 are going to grow their earnings dramatically from current levels, or, at some point, market performance will be lower than revenue growth and this figure will normalize. “Amazon is not immune. Trading at $60 for every $1 it earns is not sustainable unless it has unprecedented growth going forward,” he says.
The mathematics are against investors here and that means unrealistic expectations. “Investors buy into a company because they believe it will grow…. but this is a (share) price where many years of growth are already baked in”, he explains. “Amazon will continue to grow quickly and it’s a great company. I am prepared for it to underperform the broader market at some point as its trading level adjusts to its real future growth prospects,” he says. “The current pricing level cannot be considered to be “cheap”.
Other big-ticket companies may continue to look promising but are under political pressure, thereby adding an extra layer of risk to the investment. Alibaba Group Holding Ltd. has approximately 28 Buy ratings and some very optimistic target prices. However, founder Jack Ma is having problems with the Chinese government and the net impact on investors is not clear. In the bigger picture, the Chinese government is exerting more control over major corporations. Moreover, the tensions between the U.S. and China over trade issues, the South China Sea, Taiwan, human rights, intellectual property rights add another layer of risk. Alibaba, Tencent Holdings Ltd. and Baidu Inc. all closed down yesterday.
For those examining their retail holdings or looking to increase them, Nash offers several cautions, starting with the relationship between pre-pandemic and current share prices where further growth may be questionable.” Buying stocks that are already trading at pre-pandemic levels while their earnings are only just (now in) recovery is not likely to end well,” he says. TJ Max for example has barely returned to profitability and its share price is approximately 10% higher now than on February 2020, “Sales will continue to improve but I don’t find the current valuation to be attractive,” he says.
The pandemic accelerated the trend to online sales much faster than otherwise would have been the case meaning that a retailer’s limited online presence is another red flag in stock selection. Notwithstanding its improvement, TJ Max has a very limited online presence so that its sales depend on customers going into the store. That says Nash is not a good model. For investors looking for ‘recovery’ stocks this may not be the best choice.TJ Max’s next earnings date is May 20th, and it can only sustain its current share price with a surprise to the upside, he says.
By comparison, some retailers pivoted quickly and covered all the bases in customer service - both online and in store - during the pandemic and appear poised to continue driving both channels.
Canadian Tire Corporation Ltd. and Home Depot Inc. (both interlisted) fit that description “Both had strong online and physical advertising, but both also depended on customers physically coming into their stores and picking up goods,” he recalls. The jump to curbside pick-up, though not easy, pushed their business models forward,
Moreover, some market conditions that improved during the pandemic can be expected to continue. The massive home improvement surge has also been of benefit. Both are at new highs, but both appear to have the earnings to back them up. These stocks have high valuations but that should not discourage consideration. “While they don’t appear ‘cheap’ one could suggest that they deserve to be trading where they are and have further room to grow,” Nash says.
Some companies are well positioned to take advantage of the pandemic. Aritzia Inc. (also interlisted) was an emerging boutique chain in the years leading up to the pandemic and appears to be a direct beneficiary of the “Amazon delivery world” and questionable future of the big box retailers. The stock initially dropped 60% in March 2020 but is now 20% higher than it started in Feb 2020.
The name appears expensive (on a P/E basis) but is experiencing a high level of growth. The biggest question for a company like this is what the “new world” will look like and whether they can keep growing?
Still, at this early point in the recovery the picture is not completely clear. Projections and analysis can only go so far, and we need to get further into the recovery for a clearer view and to decide whether revisions – or additions – to holdings – are necessary.
The pandemic’s impact on retail has been extremely uneven. The technology, jewellery and automotive sectors have seen a surge in business while fashion and apparel – outside of leisurewear – have suffered, Nash says. The unclear outcome of trends such as how many people will return to the traditional office environment, with traditional business wear, is unclear and therefore those sales are difficult to estimate.
Related: With Recovery Comes Many Questions
Disclosure 1. The companies mentioned here are not specific recommendations but rather suggested for consideration between investor and advisor.
Disclosure 2. I own a small quantity of shares in Canadian Tire Corporation Ltd.