Shopping Stocks for Back-to-School

The kids just got shipped out to camp and we're already thinking about back-to-school retail. And this year it's going to be as ugly as a schoolyard fight. There are signs that inventories in the second half will be higher and retailers are pushing promotions heavily.

So if you're an investor in retail stocks, you'll need to school yourself, because as you know, back-to-school is second only to the holiday season in terms of sales and profits for most retailers. Focus on price leaders and retailers that shoppers turn to for low prices and sales, because the macro trends are looking similar to the early days of the recession, if not as grim.

According to the National Retail Federation, cargo volume in major retail ports was up 2.6% in the first half of the year, an indication that inventories are rising, and imports are expected to be up in July and throughout the rest of the year. But while the NRF is still forecasting that sales will grow this year, the pace has slowed. According to Reuters, June comparable sales were almost flat, up only 0.1% -- even below the modest 0.5% it had forecast. And as Reuters noted, that was after retailers were already bracing for the slowest monthly growth in three years.

That has retailers pulling the trigger on more promotions to bring in customers -- which will have an effect on their margins, if they're not careful. According to the marketing firm Responsys, the country's top 100 retailers sent almost 16 promotional emails to each U.S. consumer in June alone, 21% more than a year ago.

The combination of softer sales, higher inventories, and more markdowns adds up to a worry over gross margins and earnings in the second quarter that ends July 31, says Citigroup's Deborah Weinswig. She's already backing a conservative "Empty Pockets" theme for retail in the second half based on the macro trends.

If the record of consumer behavior in the recession holds true, parents will still shop for back-to-school, but this year they're going to focus on necessities like school supplies, less so on clothing and other extras. And they'll shop the stores offering the more eye-popping deals. They may also be shopping later, to take advantage of the state sales-tax holidays: The International Council of Shopping Centers has noted that most states will have theirs in the first week of August. That could push sales to the next quarter.

This penny-pinching could be more bad news for J.C. Penney (NYS: JCP) and good news for Kohl's (NYS: KSS) . As Fitch noted recently, Kohl's has the edge on promotional activity among the department stores and has gained market share as a result, while consumers are still not getting Penney's new Fair and Square pricing strategy.

We don't need to keep going on about Penney's issues here. But Kohl's is trading in the middle of its 52-week range at a P/E just over 11, which makes it a good value. Like a lot of retail companies, the stock price has been choppy and it's down 13% in the last year. It only gets a three-star CAPS rating from the Fool community, based on worries that it's running out of steam with its core consumers, and management will soon struggle to hang on to them.

Fool Seth Jayson questioned some of Kohl's cash flow recently, but declared it OK on the whole. If it can execute well on a highly promotional back-to-school season -- playing to its strengths, as it were -- it could take enough sales away from the likes of Penney's and Sears to pull off a successful quarter and boost its stock price.

On the necessities line, the macro trend will favor office-goods big-boxes such as Staples (NYS: SPLS) and OfficeMax (NYS: OMX) , and discounters where households can stock up all at once. Setting aside Wal-Mart and Target -- too many other variables there -- Staples looks like a good bet for back-to-school.

Fool Rex Moore has raised some concerns about the high amount of intangibles in Staples' balance sheet, but otherwise the Fool community likes Staples, giving it a four-star CAPS rating. It's got a good combo of big boxes and online sales (it's the second-largest online retailer after, a strong business-sales channel and even a growing IT unit catering to business.

But Staples has gotten beaten down by the macro trends in business; it hasn't quite recovered from getting smacked down in May when it reported disappointing results. The stock is trading in the middle of its 52-week range at a P/E under 10, and is down almost 17% for the year, so a spike in sales during back-to-school can only help.

Retailers will have to keep reinventing themselves beyond the back-to-school season. If you want to get ahead of that wave, check out The Motley Fool's take on these two retailers that are changing the face of retail in tough times. Click here for the free report "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail."

At the time this article was published Mercedes Cardona does not own shares in any of the companies mentioned in this article. Follow her on Twitter and on her website. The Motley Fool owns shares of Staples. Motley Fool newsletter services have recommended buying shares of Staples. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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