Slow May Sales Could Make for Some Bargain Retail Stocks

Investors will be looking to cherry-pick retailer stocks on Thursday, when merchants are expected to report lukewarm May sales. Chilly weather in the first half of the month and a late Memorial Day this year will make the month's sales an erratic gauge of retail's recovery -- and leave an opening for bargain-hunters.

Early forecasts call for disappointment, with only scattered upside reports because most retailers have been carefully managing investors' expectations during the most recent earnings season. Many have warned that the second half will be tough, even with an improving economy.

The consensus estimate tallied by Thomson Reuters calls for an increase of 2.6% in May's "comparable sales" or "same-store sales," that is, for stores open at least a year. That would be a respectable number, compared to a 0.5% increase in April, which lost sales to March due to an early Easter. May will lose sales to June due to Memorial Day falling on May 31, after most merchants have closed their monthly books. Retailers have estimated the shift will cost them around three percentage points.

Potential for Opportunistic Buying

The Memorial Day weekend sales until Saturday were robust but not enough to reverse the effect of cold weather during May's first two weeks, according to the International Council of Shopping Centers. Sales for the week ended May 29 were up 2.5% above last year, but ICSC Chief Economist Michael Niemira is holding to his forecast of 2% to 2.5% sales growth for the month.

Despite monthly fluctuations, the general consensus is that retailing has bottomed out, so any share-price dips caused by disappointing sales are opportunities to pick up stocks in the sector. Many analysts saw the recent sell-off that coincided with the first-quarter reports as a similar opportunity to grab some bargains.

Retailers are reaching the anniversary of the period in 2009 when consumers began to shake off the recession's shock, so getting a bump up in comparable sales will get tougher as the year goes on, unless consumer spending rebounds more sharply than expected. At the same time, the sector faces rising costs after squeezing them down throughout 2009, so retailers' profits will be under pressure.

Cranking Up the Come-Ons

But some consumer metrics have been increasing, which is an encouraging sign. Credit Suisse retail analyst Michael Exstein notes that consumer confidence recently reached its highest level since March 2008, before the credit crisis exploded.

With cost-cutting effectively tapped out, retailers will be focused on getting shoppers to spend more. Exstein says Wal-Mart Stores (WMT) has increased its newspaper circulars after showing disappointing sales, and both Family Dollar Stores (FDO) and BJ's Wholesale Clubs (BJ) have stepped up promotional activity.

"As retailers gradually shift from defense to offense, it appears they are beginning to turn up the dial on advertising to help sustain the current sales momentum (or lack thereof)," Exstein recently wrote.

In fact, most retailers are quite open about how they'll be focused this year on roping in shoppers and taking market share from rivals, which is good news for consumers but a yellow light for investors. Increased promotional investment will soon begin cutting into the bottom line, and shoppers have begun demanding more inventory and staffing, both of which will add to operational expenses.

Teen Clothiers Are in a Bind

While both department stores and discounters appear to be stabilizing, apparel retailers are still a concern to analysts, who fear that they may be losing their pricing edge to rising costs for fabric and labor in Asia. That puts apparel retailers in a bind -- especially the teen clothing merchants that rely heavily on back-to-school sales.

"With cool weather and no traffic-driving holiday in the month, there was little reason to buy in May," wrote analyst Paul Lejuez of Credit Suisse. In a note to investors he forecast that teen retailers such as Aeropostale (ARO), American Eagle Outfitters (AEO), Abercrombie & Fitch (ANF) and Wet Seal (WTSLA) will fall short of expectations in May. But he still recommends Abercrombie as a recovery story, along with Gap (GPS).

On the downside, a report from Phoenix Partners' Robert Samuels noted that his contacts have said vendors working with Pacific Sunwear (PSUN) are deferring payments to help the company, "always a slippery slope for a retailer and something to watch." He's looking for better-then expected sales from Aeropostale, a miss from Abercrombie and for American Eagle to meet expectations for flat sales.

The Trend Is Up

Like they did with March and April, analysts will likely want to compare May and June together before judging the real strength of the retail sector going into the key back-to-school shopping season in July. As the ICSC's Niemira notes, the average of March and April was 4.9% growth, so the overall trend is up.

As reports filter out tomorrow morning, investors will be the ones sifting through the markdown bins.