A Rise for High-End Retailers?

Low-end stores have done well through the downturn. Customers at fancier shops, though, should be less burdened by higher fuel costs

By Amy Tsao

Lucky for retailers and the U.S. economy, consumers are a resilient bunch. They've shopped through the downturn, through a threat of more terrorist activity, through uncertainty of war in Iraq, and now through sharply rising fuel costs. Indeed, consumers' willingness to spend has made the difference between recovery and recession many times over in the past few years.

For the retailing industry, the past year has been particularly strong for the higher end, as more affluent consumers benefited from tax cuts and a rebounding stock market, while the lower end tightened their belts and waited for the labor market to perk up. Luxury brands such as Coach (COH ), a maker of leather bags and accessories, and jeweler Tiffany's (TIF ) have been on the rise.

Even the high-end department stores –- such as Saks (SKS ), Nordstrom's (JWN ), and Neiman-Marcus Group (NMGa ) –- have shown impressive performance in recent months. In May, all three posted higher same-store sales (sales at stores open at least a year) of about 9% each. Hoping to participate in the resurgence at the higher-end, May Department Stores (MAY ) said on June 10 it will pay a hefty $3.24 billion to buy the upscale Marshall Field's chain from Target.

The relatively rich have also been spending more time and money at stores once perceived as the stomping ground of the lower end. A more varied mix of customers has been a boon to such retailers. Take Costco (COST ), which trades at $39, or about 19 times forward earnings per share. It has bounced back nicely in recent months. Known for low prices for products in huge quantities, Costco appeals to "the upper-middle-class suburbanite who's relying on them for more of their goods at a better value," says Michael Silverstein, a partner at Boston Consulting Group and the author of Trading Up: The New American Luxury.


  In general, most low-end retailers have been chugging along quite nicely. In May, discount giants Wal-Mart (WMT ) and Target (TGT ) posted monthly same-store sales gains of 5.9% and 4.6%, respectively. For the same period, Warehouse stores Costco and BJ's Wholesale (BJ ) turned in impressive increases of 16% and 12.1%, respectively.

In the near term, however, many analysts expect high-end retailers to be the better performers because their customers are less burdened by rising fuel costs. For a family making $75,000 per year, the increases in gasoline amount to only a few hundred dollars annually, explains Silverstein. "It's not causing them to cancel vacations, stop eating out, or [refrain] from buying a new car," he says. But earners of $150,000 or more are able to cope even better: "They're sitting on stock-market gains and stable and increasing home values."

Lofty valuations for high-end retailers reflect the anticipation of continued strength. While the valuations aren't outrageous, says Eric Jemetz, senior equity analyst at New York City-based asset management company Rockefeller & Co., he urges caution for the long term. Coach, though it's one of the fastest-growing companies in luxury retail, was trading around $44 as of June 9, or 27 times its forward EPS. It's projected to increase earnings about 23% in fiscal 2005, ending next June. Nordstrom's was trading around $41 as of June 9, or 16 times its forward EPS. Saks is around $15 per share, or 17 times forward earnings.


  For the near term, "I would still overweight higher-income retailers even at these [lofty] levels," says Jemetz. "The lower-end retailers are at more risk." (Jemetz' firm owns Tiffany, a stock he also owns personally.)

One downtrodden name in luxury retail that some investors like is Tiffany. Shares in the jeweler have fallen 16% so far this year, to around $36 as of June 9, amid recent reports that sales in Japan, its second-largest market after the U.S., are faltering. But Dave Malmgren, portfolio manager at Wealth Trust Management, is expecting that efforts to revamp Japanese merchandising and marketing will pan out. "We're looking at long-term rate of about 17% earnings growth over five years," he says. At a valuation of 22 times forward earnings, it's looking reasonable, Malmgren says. (His firm owns shares in Tiffany.)

The stalwarts of discounting could be hurt if fuel prices remain stubbornly high and consumer-goods prices keep rising. That would be bad news for discounters Wal-Mart and Target, who so far have been somewhat shielded by virtue of their size and market share. "Wal-Mart will struggle to make its aggressive numbers," predicts Silverstein, since the core of its customer base "is struggling to make ends meet."


  The biggest losers on the low end will likely include the dollar stores. These discounters were a favorite in the retail sector just two years ago, as the soft economy attracted a range of shoppers. Shares in Family Dollar (FDO ), Dollar General (DG ), and Dollar Tree (DLTR ) have all declined since the start of 2004. "This is where we have to be more cautious," says Jemetz. "The sales growth trends aren't so strong at these stores."

Still, as the economic recovery gains momentum and pricing power begins to return, certain lower-end retailers could benefit. As traditional department stores toy with price increases, "reach" shoppers -- an industry term for customers who can afford to shop at department stores only during periods of heavy discounting and promotional activity -- may decide to seek bargains at off-price stores.

According to a recent report by J.P. Morgan retail analyst Brian Tunick, one beneficiary might be TJX Co. (TJX ), which operates Marshall's and T.J. Maxx. Its valuation is a bit rich, with TJX shares trading a bit above $25 as of June 9, near a 52-week high. That's a price-earnings ratio of 17, above the stock's historical average p-e of 14.9. Tunnick rates TJX neutral. (In the past 12 months, J.P. Morgan provided investment banking services to TJX.)

Better times for the high end won't last forever, certainly. Tax-cut-fueled gains for the rich "[are] not going to last," says Jemetz. Still, it's likely that all the recent good news about the economy should benefit wealthier consumers and the retailers that serve them more than it does the lower end, at least for the rest of this year.

Tsao is a reporter for BusinessWeek Online in New York

Edited by Beth Belton

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