Consumer Spending Is Driving Retail Stocks Higher

There hasn't been too much to get excited about in the retail industry over the past couple of years, given the spike in unemployment and tightening of consumer credit. But all that has changed, as the retail sector has been one of the best- performing groups in the S&P 500 year to date.

And one company that has been especially resilient to a weak economy is Macy's , in part because of its affluent customer base. The real story is that there is even more upside to the stock as it enters the athletic apparel business. It also appears to be rather cheap when compared to its peers. 

So Macy's is getting into the athletic apparel business, which should prove to be a hot market going forward. This includes offering the likes of Nike and Under Armour in its stores. The other big initiative is the store-in-a-store concept for selling LIDS Sports merchandise, via Locker Room by Lids store in stores. It plans to open 175 of these in the first half of 2014. This should help the company meet, and possibly exceed, its lofty expectations for earnings per share. 

Macy's is expected to grow 2013 EPS by 21% year over year and 2014 EPS by 13%. Couple this with its 12.8 P/E and the stock appears to be a "growth at a reasonable price" opportunity. Meanwhile, top peer Nordstrom  trades at 15, and Dillard's at 10.3. Sure, Dillard's appears cheaper, but if you dig a bit deeper you'll see why. Analysts expect the company to grow EPS by an annualized 5% over the next five years.

Macy's also continues to develop its "My Macy's" initiative, which it implemented three years ago. This initiative allows the company to tailor its merchandise and marketing to each specific store. This appears to be working, as the retailer continues to see strong same-store sales. The "My Macy's" initiative should also help bring in more Gen-Y shoppers, which are quickly becoming the largest shopper base in the U.S.

The "sweet spot"
Investors and shoppers alike also have Dillard's and Nordstrom as options in the department store space. While Macy's captures the middle ground, and what a large middle ground it is, Dillard's is more on the bottom end, while Nordstrom caters to the higher-end shopper.

Investors should be encouraged by the steps Nordstrom is taking to cater to the less affluent customers, looking to break into Dillard's market. The company has launched its Nordstrom Rack stores, which offers Nordstrom products at a 30% discount to normal prices. The company plans to increase its Rack locations from the current 120 to 230 by the end of 2016. 

Overall expansion efforts should also help Nordstrom. The company is looking to expand into Manhattan and Canada. In August, Nordstrom managed to post EPS of $0.93, well above the $0.75 from the same period last year. This comes as same- store sales were up 4.4%. 

Meanwhile, the lower-market department store operator, Dillard's, has also managed to perform well, posting its twelfth straight quarter of positive same-store-sales growth. 

Dillard's posted second quarter EPS of $0.79, above the $0.63 from last year. The retailer did this with only a 1% increase in same-store sales. But Dillard's does have the highest days of inventory on hand among the three department store chains at 122 days. And it ended the second quarter with inventory in comp stores up 8% year over year. This could be a sign that shoppers are trading up from Dillard's to the likes of Macy's. 

Bottom line
Macy's operates in the "sweet spot" of department store retailers, as it is able to cater to mid to upper-income shoppers. This section of the market is not only large, but also somewhat resistant to economic pressures. And although Nordstrom is looking to step down, with its Rack stores, Macy's is the still the best investment in the space given its valuation and ability to grow earnings.

Macy's has grown EPS at an annualized 20% over the last five years. Look for this trend to continue as the economy picks up, and take the chance to buy Macy's while its PEG ratio is at only 0.94. 

You don't have to invest in department stores to rule retail
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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool owns shares of Dillard's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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