(SKS) U.S. Retail Still Rolling – Zacks Industry Rank Analysis

Industry Rank Analysis 11-15-11

Before you know it, Christmas will be here. That is something that tends to bring retail front and center to the minds of investors.

Rumors of the death of the U.S. consumer appear to be premature. Despite extremely low levels in the surveys of consumer confidence, people are still going out to shop. Personally I don’t like to rely on those surveys, because what people say to the poll takers is often very different from what they actually do.

A wide variety of Retail industries are doing very well based on the Zacks Rank. In light of the second month in a row of surprisingly strong Retail Sales numbers, it looks like the retailers might continue to stay on top for a while.

Also in the third quarter, inventory growth was a drag on the economy, so the retailers are probably going into the all-important Holiday season with lean inventories and will not have to go on a price (and margin) slashing spree. For Retail Investors, this could be the season of Santa, not the Grinch this year.

Zacks Industry Classifications

The Zacks industry classifications are very fine, with 258 different industries tracked. It is not particularly noteworthy if a single small industry shows up doing well, a single firm with good news can propel a one or two firm industry to the top (or bottom) of the charts. It is interesting when you see a cluster of similar industries at the top of the list. The same holds true for the bottom of the list.

The definition of size that matters here is not the total sales or market capitalization but the number of companies in the “industry.” Honestly I think we cut the definitions of an “industry” too fine, but when 10 of the 15 groupings that make up what one thinks of as “Retail” overall are in the top 50, the story is pretty clear regardless of how small we make the groupings.

Retail Takes 6 of Top 20

There are six different Retail “industries” clustered in the top “20,” although due to ties, the rankings jump from 18 to 32. Some of them are on the small side, with two of them having just four members. Others, including Drug Stores and Auto dealers are larger than average with 11 members. None of the ten “industries” saw an increase in its average Zacks Rank, although some slipped a few places in the ranking from last week.

If the Zacks Ranks were distributed randomly, one would expect that only 5% of the members of these “industries” would earn the coveted Zacks #1 Rank (Strong Buy). Instead, 16 of the total of 96 (16.7%) have earned that distinction. If it were random, only 15% would hold Zacks #2 Ranks (Buy) but actually 36, or 37.5%, hold it.

In terms of target shoppers, the firms range from those that cater to the very wealthy, such as the high-end department store chain Saks (SKS) to those that cater to a decidedly less affluent clientele such as Family Dollar (FDO). That would also probably hit sales at some of the mid-range stores such as Bed Bath & Beyond (BBBY) or Macy’s (M) that currently hold number Zacks #1 Ranks.

There are a wide variety of Market Capitalizations to choose from on the two lists, ranging from mega-caps CVS-Caremark (CVS) and Target (TGT) down to sub-$100 million micro-caps. The valuations are for the most part what I would call reasonable: not compelling, but not at scary nose-bleed levels either. There are a few that I would be cautious about on a valuation basis, particularly on this year’s earnings.

Also, while things are going well now, or at least much better than people had been anticipating (and the Zacks Rank is driven by the change in expectations and earnings surprises), I do remain worried about consumer spending in 2012. Unless Congress does something, the payroll tax cut that has been in effect for this year will expire on January first. For someone earning $50,000, that means $1,000 less in take home pay, and that will probably result in a lot less discretionary spending.

That will be a very big issue for the Retailers that either mostly cater to the middle to lower class customer, or which sell very discretionary items. Since the tax increase will max out at $2,134 (2% of the $106,700 limit on payroll tax collections), that will be much less of an issue for a firm like Saks. It could be a very serious issue for some of the stores with a poorer clientele, such as Dollar Tree (DLTR) and Big Lots (BIG).

One should, however, not make the mistake of thinking that a weak economy is bad for all retailers. For example, if people are not confident enough to buy a new car, it means they will be keeping their old jalopy on the road longer. That can only be good news for the auto parts stores like O’Reilly (ORLY) and Advance Auto (AAP).

The Zacks Rank is, however, better used as a short term timing/trading tool, not as a guide towards long-term investing. Its maximum impact comes in less than three months. Thus even if you agree that there will be substantial headwinds for the consumer next year, there may still be a good trade or two to be made.

In evaluating the Zacks Industry Ranks, you want to see two things: a good overall score (low, meaning more Zacks #1 and #2 Ranked stocks than #4 or #5 Ranked stocks) and some improvement the relative position from the prior week. It is also helpful to understand exactly what the Zacks Industry Rank is.

The Zacks Industry Rank is the un-weighted average of the individual Zacks ranks of the firms in that industry. It does not matter if the stock is the 800 lb gorilla that dominates the industry or some very small niche player in the industry — they have the same influence on the industry rank.

Also, that means that the bigger the industry in terms of number of firms, the less influence any given company has on the industry rank. It also implies that small industries, with just two or three firms, should be the ones found at either the top or the bottom of the list. After all, if there are only two firms in the industry, it is relatively easy to get a Zacks rank of 2.00 (i.e. one with a Zacks Rank of #1 and the other with a #3). Right now, that industry rank would be tied for 6th place among the 255 industries tracked.

The same obviously goes for the bottom of the list as well. If there are 50 firms in the industry, and it ends up at one of the extremes, that means there has to be something pretty significant going on. Thus, I do not always focus on the very highest rated industries, but on the highest rated ones in which there are a large number of firms.

Click here for the Zacks Industry Rank List: http://www.zacks.com/zrank/zrank_inds.php

ADVANCE AUTO PT (AAP): Free Stock Analysis Report

BED BATH&BEYOND (BBBY): Free Stock Analysis Report

BIG LOTS INC (BIG): Free Stock Analysis Report

CVS CAREMARK CP (CVS): Free Stock Analysis Report

DOLLAR TREE INC (DLTR): Free Stock Analysis Report

FAMILY DOLLAR (FDO): Free Stock Analysis Report

MACYS INC (M): Free Stock Analysis Report

O REILLY AUTO (ORLY): Free Stock Analysis Report

SAKS INC (SKS): Free Stock Analysis Report

TARGET CORP (TGT): Free Stock Analysis Report

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