Interactive Investor

These are the three American retail giants I would buy cheaply

25th May 2022 07:59

Rodney Hobson from interactive investor

Following grim results from some of the world’s largest retailers, our overseas investing expert reveals the bargains he’s spotted in the aftermath.

When the going gets tough, the weak go to the wall and the strong eventually come out stronger. So it is in the American retail sector, where strong brands should ultimately pay off for patient investors. 

Two well-known names in the US, Walmart Inc (NYSE:WMT) and Target Corp (NYSE:TGT), produced undeniably disappointing figures for the latest quarter. Even Walmart admitted its performance was unexpected, with pre-tax profits down a whopping 25% to €2.9 billion in the three months to the end of April.

Yet sales were actually 2.4% higher at $141.6 billion. Margins were badly squeezed as inflation, particularly for fuel and food, fed into supply chain costs and the problem was compounded by consumers switching into lower priced items.

Clearly revenue growth in low single digits is nowhere near enough considering that US inflation hit 8.3% in April and could well move higher. Walmart expects sales growth of 5% in the current quarter, better but still not keeping up with inflation, and it has removed earlier guidance for a rise in profits. Earnings per share are now expected to hold steady but, considering that the February-April quarter fell short of management’s own expectations, there is clearly scope for further disappointment

Source: interactive investor. Past performance is not a guide to future performance.

Smaller rival Target pointed to higher wage and fuel costs plus disruption to the supply chain as it posted profits well below expectations. Target's adjusted earnings per share fell 41% to $2.16, far worse than even the most pessimistic analysts feared.

Target’s management blithely assumed trends during the pandemic would continue as restrictions eased. When consumers switched spending to cheaper products or to services, the retailer was left with merchandise that had to be sold off at cut prices.

The rest of this year is likely to continue to be tough for retailers. Preliminary figures showed retail and food service sales growth slipped from 1.4% in March to 0.9% in April and a further slowdown is expected by analysts. At the same time, supply chain issues, although easing, have not been completely addressed, rampant inflation is always difficult to rein in and the certainty of more interest rate rises by the Federal Reserve Bank will weigh on consumer confidence.

However, Walmart and Target are strong and solid companies that will withstand the pressure, while weaker rivals will struggle. Target has a particular advantage in that it uses a wide range of city stores to fulfil online orders on the day they are placed.

Furthermore, the bad news has already been factored into their share prices – Target fell 25% when its figures were released and Walmart also suffered, though to a slightly lesser extent. Walmart shares are down from $157 in mid-April to $124 now, where the yield is 1.8%. Target peaked earlier, in July last year, at $260, but most of the drop to $150 has again come since mid-April. The yield is more attractive at 2.34%.

Source: interactive investor. Past performance is not a guide to future performance.

Also under the cosh has been home improvement retailer The Home Depot Inc (NYSE:HD), which produced its best ever first quarter sales at $38.9 billion, up 3.8% on the previous year. Net earnings rose 2.1% to $4.23 billion.

Despite facing the same problems as Walmart and Target, Home Depot has raised its sales and earnings guidance for the full year. Even so, the shares have fallen from $415 in December to $287 now, giving a yield of 2.4%.

Source: interactive investor. Past performance is not a guide to future performance.

Hobson’s choice: I tipped Target three years ago at $86.50 and anyone following my advice to buy up to $90 has done very well. The recent fall makes the stock a buy again. I felt cautious about Walmart at $137 after its last update three months ago. Now the shares are lower it is worth considering a buy, but I prefer Target for its higher yield and clearer business model. However, Home Depot looks an even better prospect.

Rodney Hobson is a freelance contributor and not a direct employee of interactive investor.

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