3 Consumer Stocks to Covet in 2016

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Inside A J.C. Penney Co. Store Ahead Of Earnings Figures
Michael Nagle/Bloomberg via Getty ImagesJ.C. Penney is enjoying better than 6 percent growth, while Walmart, Kohl's and Macy's are all seeing stagnating or falling same-store sales.
By Ryan Derousseau

Describing 2015's stock market returns is like offering up reactions to toast with butter. [Meh. Yawn.]

While 2015 had some cringeworthy moments -- like when China's market took a dive this summer -- for the most part, stocks are ending the year close to where they began, showing only a 1.5 percent boost in the Standard & Poor's 500 index (^GSPC). It's a far cry from the 63 percent return we saw through the three prior years.

Consumer discretionary companies, however, offered a bright spot. As a whole, the sector rose 12 percent; consumers have more money to spare, thanks to lower gas prices and unemployment, combined with higher wages. It's a good time if you're a company selling cars, homes or apparel.

But has the moment passed? With the Federal Reserve expecting to raise interest rates in December, tighter lending could persist. Although gas prices remain low, could oil soon become pricey again? And with seven-year long bull market rolling along, is it time for a correction? These are all primary concerns going into 2016.

To navigate this, we talked to portfolio and money managers to help find bright spots within consumer companies that could show signs of life, even if these issues become a problem.

American Eagle Outfitters (AEO). The Fed rate increase will certainly impact consumer companies. Historically, when rates move up, consumer discretionary and consumer staple companies perform the worst in the 12 months after the boost. But this isn't your normal rate rise -- unlike past increases, the Fed isn't "really trying to tighten monetary policy, but normalize it," says Brad Sorensen, an analyst at Charles Schwab (SCHW).

Since rates are already at historic levels, the increase isn't to halt inflation, which remains low. Instead, it's to move the rates back to a normal level. While typical rate raises hurt consumer companies, this time around they may be spared. But that doesn't mean you should look to consumer-focused companies in droves. "We're advising clients not to get too aggressive," Sorensen says.

Instead, it's time to get picky. One company that Jeannie Wyatt, CEO of South Texas Money Management, likes is American Eagle Outfitters. The stock fell 50 percent from 2012 to 2014 as teenagers shunned high-priced brands and American Eagle failed to control its inventory.

But in 2014, embattled CEO Robert Hanson left and American Eagle closed 100 stores that performed poorly. It has done a better job of making sure it's not overstocked with clothes, creating a 17 percent return this year. Wyatt gives AEO stock a price target of $24, and the stock also pays a generous 3.1 percent dividend.

Group 1 Automotive (GPI). While gas prices sit near $2, there's fear that they could rise in the next year, pinching consumer pockets.

Don't expect them to change dramatically, though. Oil inventory levels remain high, which means there's an overabundance of supply. This has continued even as consumers pump more gasoline. Outside of a major Middle East conflict or military intervention, Sorensen doesn't see gasoline rising above $3 in 2016.

But there's "not a lot of correlation between gas prices and consumer stocks," he says. That's because of other factors at play, like higher health care costs, which limit directly using funds saved from gas for mall purchases.

It does, however, push people to buy more gas-guzzling vehicles that offer many auto companies higher margins. One company that Eric Marshall, a portfolio manager at Hodges Mutual Funds, likes is the dealership Group 1 Automotive.

The average age of cars on the road is 11.5 years, a new high. When the economy struggled, people held off on purchasing new vehicles. And as improvements took hold, the last to feel the benefits were middle-class Americans. That has started to change, as wages increase and employment levels remain high. "We're still in the early innings of the replacement," Marshall says. "As long as employment is doing well, we think auto replacement consumptions will continue."

Group 1 is cheap -- GPI stock is trading at 11 times 2016 earnings. That's below most of the industry, which trades 13 to 15 times 2016 earnings. Marshall has a price target at $110 for GPI stock.

J.C. Penney Co. (JCP) The biggest drag on a number of companies heading into 2016 may just be their outsized performances over the past few years. But that doesn't mean the market won't grow. You just can't expect the large growth rates seen from 2012 to 2014. Sorensen expects growth next year of "mid-to-upper single digits."

Finding companies that have much room to improve will be important since the ceilings for many stocks have already been reached. That can also mean taking a bet on companies that have struggled for years. Marshall sees that opportunity in J.C. Penney.

In many ways, Penney's became a laughing stock of the retail world over the previous five years. Trying to adapt to weakening sales due to online shopping, it tried everything from marketing to higher end consumers, cutting back promotions and altering stores. They all dramatically failed. But now the company has gotten back to its roots with strong promotional plans, keeping its inventory at proper levels and cutting expenses.

While Walmart Stores (WMT), Kohl's (KSS) and Macy's (M) all see stagnating or falling same-store sales, it's Penney's that has better than 6 percent growth. And JCP stock is positioned to go up. "It's been so bad for so long, it now has opportunity to gain back market share," Marshall says.

The stock is priced at $8, which is the value that Marshall places on the company's real estate alone. A fair price for JCP stock, he says, would be $16, which offers growth in a market where there's little to find. "You're buying the real estate, but getting the retailer for free."

Ryan Derousseau is a journalist with nine years of experiencing writing about investing and leadership issues. His work has been read in Fortune, Money, CNNMoney and Fast Company, among other publications. You can find more from him on Twitter @ryanderous.
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