Costco, Home Depot, and 3 Other Retail Stocks to Scoop Up Now—and 1 to Avoid

Stores now are discounting some merchandise, particularly apparel, setting off a wave of worry for the industry. Those concerns intensified on June 7, when Target lowered its forecast for the second time in three weeks, citing the issue.

Yet, retailers such as Academy Sports and Outdoors (ASO) have painted a brighter picture. Even Walmart hasn’t warned that inventory will further hurt results. “Target’s problems definitely look to be company-specific,” says John Zolidis, president of Quo Vadis Capital.

That creates an opportunity for investors. But to make the right choices, they must be discriminating. Some battered shares, such as Gap ’s (GPS), are beaten down with good reason.

It might be tempting to avoid the sector altogether, given mounting worries about a downturn and the fact that consumers are facing persistently high inflation. “The average wage is going up a lot slower than the price of food, energy, and housing; consumers have to pull back somewhere,” says Brian Frank, portfolio manager at the Frank Value fund. “I fear that could bleed into higher-quality companies.”

But the best strategy is to look for defensive companies that aren’t as exposed as the emperor in his new clothes if they get the fashion formula wrong.

Academy Sports and Outdoors

Academy Sports and Outdoors delivered strong quarterly earnings, and it wasn’t as cautious in its outlook as larger rival Dick’s Sporting Goods (DKS). Academy Sports, worth about $3.3 billion, also announced a new, $600 million stock repurchase plan. Gross margins contracted less than expected, and were helped by expanding merchandising margins. Management says it hadn’t noticed any change to the cadence of its business this quarter—a nice contrast to Target. CEO Ken Hicks tells Barron’s that Academy Sports hasn’t seen its customers trading down to cheaper products.

AutoZone

AutoZone (AZO), an auto-parts retailer, is one of the cheapest stocks in that retailing group; it trades at just over 17 times expected forward earnings. Car-parts merchants tend to hold up well during tougher economic times. While consumers may pull back on miles driven amid higher gas prices, other sales catalysts can offset that pressure. America’s automotive fleet is aging, but high prices for used vehicles, coupled with semiconductor-chip shortages that have reduced production of new models, are pushing motorists to continue repairing their cars, especially if they are concerned about the direction of the economy.

Costco Wholesale

Costco Wholesale (COST), a long-term winner, has gained more ground against its competitors throughout the pandemic. The company gets high marks from consumers when it comes to value, a factor that is becoming more top-of-mind as inflation remains stubbornly high. The chain’s membership fees provide a bit of stability to its profits. In fact, Costco is the only megaretailer to still provide monthly same-store sales updates, and these have been persistently strong. The shares aren’t cheap, but investors haven’t hesitated to pay a premium for them in recent years.

Dollar General

Dollar General (DG) delivered a strong first quarter and an upbeat outlook when it reported results last month, in contrast to Walmart. Compared with big-box retailers, the discounter’s numerous stores tend to be closer to lower-income consumers who might be more closely watching how many miles they’re driving, given high gas prices. Dollar General has made strides in areas like fresh food, and although it may be a winner among consumers now trading down to save money, its long-term track record shows that it performs well in good times, too.

Home Depot

Home Depot (HD) reported a beat-and-raise quarter last month. That shows that its customers, particularly construction and renovation professionals working through big backlogs, are still spending. Rising interest rates could hurt home sales, especially in light of already high home prices, but that isn’t as bad for Home Depot as it could be for home builders. In fact, current economic conditions could push many homeowners—who tend to have higher incomes than renters and are less affected by inflation—to remodel their houses, rather than move.

Gap

Gap shares have sunk, and there are no signs that they’ll quickly resurface, considering the company’s weak sales and profit outlook. Much like Target, Gap tends to sell somewhat basic apparel, which is out of favor with consumers, and so could feel increased pressure to discount its wares. Gap’s Old Navy unit, formerly its growth engine, meanwhile is dealing with a leadership transition. In addition, while the top line has held up at many retailers, Gap’s revenue slipped in its first quarter, and the company has slashed its earnings guidance for all of 2022.

Write to Teresa Rivas at teresa.rivas@barrons.com