3 Retail Stocks to Hesitate on, for Now

Retail stocks have taken a beating lately due to rising margin pressures. Recently, the likes of Walmart (WMT) and Target (TGT) have missed their second-quarter earnings estimates by a country mile, suggesting that decreasing profit margins could be an industry-wide phenomenon moving forward.

From a personal vantage point, I’m incredibly concerned for labor-intensive businesses due to the tight jobs market, which owns nearly two jobs for every unemployed American. Additionally, resilient commodity prices could cause a prolonged inflationary period, subsequently sustaining high-wage demands. Thus, I’m bearish on the following three stocks.

The Home Depot

Home Depot (HD) is overcooked and overvalued at the moment. The company might have surpassed its first-quarter earnings estimate by 40 cents per share; however, the firm will likely reach a cyclical peak soon.

According to Wells Fargo (WFC) analyst Zachary Fadem, “As the macro environment evolves, we see elevated risk of spend shift away from the Home Furnishings category via inflation, COVID pull-forward, lower-income consumer pressures, and shift back to experiences such as travel.”

Fadem’s claim relates to the consumer utility cycle, which essentially says that a robust consumption period will always be followed by a period of saving. Thus, companies that sell home improvement products, such as Home Depot, will likely be faced with an eroding discretionary spending base.

Furthermore, Home Depot stock seems overvalued on a sector relative basis. For instance, its price-to-earnings is at a 66.94% premium to its peers. Additionally, HD’s price-to-sales ratio is also at a surplus of 1.2x.

Turning to Wall Street, Home Depot earns a Strong Buy consensus rating based on 17 Buys and 5 Holds rating assigned in the past three months. The average Home Depot stock price target of $354.57 implies 24.33% upside potential.

Walmart

Walmart missed its first-quarter earnings estimate on Tuesday, which resulted in an immediate stock price slump of more than 10%.

The company reported an earnings miss of 18 cents per share, with its operating expenses reaching 21%. Furthermore, Walmart’s full-year earnings-per-share decreased by 23.7% year-over-year, thus, leaving its investors with declining residual value.

Walmart’s earnings slump shouldn’t be a surprise as it’s an extremely capital-intensive business. For example, the firm’s net income per employee of $5,944.78 is 76.91% lower than its sector peers, and 13.69% higher than its 5-year historical average.

Another worrying factor for Walmart is the rising freight costs that are inextricably linked with supply-chain congestion. Walmart’s business model has integrated an online sales system, which relies on speed and cost-efficiency. However, without efficiency, the segment might stagnate for the foreseeable future, in turn slowing down Walmart’s topline sales.

Turning to Wall Street, Walmart earns a Strong Buy consensus rating based on 21 Buys and 5 Holds rating assigned in the past three months. The average Walmart stock price target of $156.65 implies 27.95% upside potential.

Simon Property Group

Simon Property Group (SPG) is a real estate investment trust (REIT) with an objective of investing in malls that include premier shopping, dining, and mixed-use destinations.

The possible implications for Simon Property Group range from retail contagion to a cyclical downturn for REITs.

Starting with the prior. Shopping mall REITs usually charge their lessees a percentage of sales amount in addition to base rent, which could affect the variable income prospects of the fund.

Furthermore, REIT investments have also reached a cyclical peak due to calming pull inflation (purchasing inflation) and rising interest rates. To elaborate, market participants usually attempt to invest in REITs prior to a pull inflation surge as a means of taking advantage of rising appraisals and rent increases. However, with interest rates set to hike, REIT investments aren’t all that attractive anymore.

Simon Property Group isn’t in great shape from a quantitative vantage point. The REIT’s trading at 12.35x its book value, suggesting that investors have placed too much emphasis on the asset’s reopening prospects. In addition, Simon Property Group has a -8.26% forward free cash flow per share estimate, indicating that the REIT’s intrinsic value might go astray.

Turning to Wall Street, Walmart earns a Strong Buy consensus rating based on 21 Buys and 5 Holds rating assigned in the past three months. The average Walmart stock price target of $153.29 implies 24.86% upside potential.

The Bottom Line

Many retail stocks are in a tough spot at the moment amid surging input costs stemming from wage demands and resilient commodity prices. Furthermore, consumer spending power is eroding, and in turn, suppressing retailers’ income statements.

There’s no one way to protect an investment portfolio from the economic headwinds that the financial markets are faced with. However, avoiding certain stocks might make a difference in the long run.

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