By JACK HOUGH
This would seem to be a difficult time for chain stores in general. A weak economy is keeping shoppers cautious while giant discounters like Amazon (AMZN)
How can investors tell which chains are likely to win and lose in coming years?
One of the most important factors to consider today is whether the items a store sells can be bought for less from a retailer like Amazon, says Anthony Chukumba, a retail analyst with BB&T Capital Markets.
Best Buy, which on Tuesday reported a 91% drop in second-quarter profits, has a handful of private brands like Insignia televisions and Rocketfish video cables. But mostly it sells name-brand electronics that customers can buy anywhere. That leaves is vulnerable to "showrooming", where shoppers inspect goods at Best Buy before buying them elsewhere for less.
On the other hand, Pier One Imports specializes in selling items customers can't buy elsewhere. That and reasonable prices have contributed to its success, says Mr. Chukumba who calls Pier One his favorite retail stock. Earnings for the company rose 26% last quarter.
Home Depot (HD),
Store size has contributed to the success of the "dollar stores" -- Family Dollar, Dollar Tree (DLTR),
Bed, Bath & Beyond (BBBY)
Of course, stock investors must compare the growth prospects of chain stores with their stock valuations. Whole Foods enjoys strong sales growth and healthy margins, but its shares sell for 38 times this year's earnings forecast. Family Dollar and Home Depot sell for 18 and 19 times earnings, respectively. The broad S&P 500 index of U.S. stocks trades at about 14 times earnings.
With investors paying such rich prices for growth, the best returns might await those who can spot chains that trade cheaply today but are likely to turn things around. The key to that, says Mr. Chukumba, is determining whether their problems are "cyclical" or "secular".
Cyclical changes are those related to swings in the economy and tend to be temporary. Many chains saw sales declines following the financial crisis but have since bounced back. Secular changes, on the other hand, are longer-term shifts in business conditions. One such change from recent years is the rise in online sales as a percentage of consumer spending.
Telling the two apart isn't always easy. GameStop shares sell for just six times earnings. A valuation that low suggests investors are put off by what they view as secular changes in video game sales. These include the rise of smartphone games and free, online multi-player games, as well as the threat that game downloads will replace discs, and that GameStop, which reported a 32% decline in second-quarter earnings, will go the way of record stores.
That's not likely to happen in the foreseeable future because games have simply gotten too large, says Chukumba. He views GameStop's decline as a temporary one caused by a lull in the gaming cycle. Nintendo will launch an updated version of its Wii gaming console later this year and Sony and Microsoft are working on the next generation of Playstation and Xbox consoles. All will reportedly use discs.
If the new machines give game sales a boost, GameStop could prove a good deal at today's price. The company is debt-free.
J.C. Penney, on the other hand, owes close to $3 billion, more than half its stock market value, and recent credit downgrades have dragged its bond rating well into "junk" territory. Chief executive Ron Johnson, who helped launch Apple's highly successful retail chain and joined Penney nearly a year ago, has outlined a plan to simplify pricing, improve the store experience and focus on exclusive brands.
That plan could work, but its unclear whether it will work fast enough to improve the company's financial standing, or whether the economy will cooperate.