3/20/99
Although much of the equity market is focused upon emerging technology and internet companies, I believe that the more prudent growth investor would look at the retail sector, and more specifically, the specialty retail industry. Why specialty retail? Our affluent society is driven by growing consumer spending. People are both becoming increasingly affluent, and more importantly, they are feeling increasingly affluent; that is, consumer confidence is rising. This is the essence of the United States' longterm economic prosperity.
The following stocks are considered highly likely to outperform the market and fit well with current economic trends, which are explained further below. Particularly, I would focus upon companies with strong brand names that appeal to upper income consumers.
Abercrombie and Fitch Co. (NYSE: ANF, $86) and Saks Inc (NYSE: SKS, $27)
ANF and SKS are both valued at over $4 billion and sell high quality apparel. Abercrombie sells casual apparel through its catalog and through its retail stores. Earnings growth at Abercrombie is driven by revenue growth. Revenue growth is driven by increased catalog and same store sales as well as Abercrombie's continued expansion of its retail outlets. Abercrombie's earnings consistently beat analyst expectations: continued 30% earnings growth can be expected from Abercrombie. Considering the store's highly regarded brand and history of stellar earnings growth, an earnings multiple of between 40 and 45 is justified. Therefore, I have an 18 month price goal of $130-$145.
Like ANF, SKS is a high quality retailer that appeals to the upper income end of the market. I view this focus as a positive, because income growth has recently been concentrated in the upper income brackets. Saks and Abercrombie both benefit from the trend favoring high quality merchandise; increased buying power on the part of consumers should continue to drive demand for high quality merchandise, and therefore demand at high quality retailers such as Abercrombie and Saks. However, Saks recently warned that this year's earnings could be as much as 6.7% below expectations, as realization of the benefits of cost cutting efforts is delayed. Earnings growth at Saks will be driven by the opening of new Saks stores and cost cutting efforts, and will likely range between 18% and 20% annually. Considering Saks' powerful brand and its recent negative earnings warning, a multiple of between 16 and 18 may be justified. Therefore, I have an 18 month price goal of $40 to $45.
Barnes and Noble Inc (NYSE: BKS, $33)
Barnes and Noble is valued at over $3 billion and sells books, magazines, and increasingly music, through its Barnes and Noble superstores and B. Dalton mall stores. Barnes and Noble is the world's largest bookseller, and has recently announced plans for a spinoff of its online unit, barnesandnoble.com. The separation of the brick and mortar bookstore business from the online retailing business should enhance the value of each. For the brick and mortar stores, the divorce from the .com unit will improve its balance sheets by eliminating debt and a continual source of losses. For the .com business, separation will allow barnesandnoble.com to enjoy the high valuation typically enjoyed by other internet companies such as amazon.com. If barnesandnoble.com is valued as richly as Amazon.com is, on a per revenue basis, then the portion of barnesandnoble.com owned by Barnes and Noble Inc. could be worth $20 to $25 per share. Barnes and Noble can be expected to increase earnings by about 25% annually. Considering Barnes and Noble's strong brand, its plans for rapid expansion, and its upcoming barnesandnoble.com IPO, a multiple of between 30 and 35 can be justified. Thefore, I have an 18 month price goal of $45 to $55.
Gateway2000 Inc. (NYSE: GTW $68)
Gateway2000 is at over $10 billion dollars and is among the leading sellers of computers, second only to Dell Computer Corp. Gateway can be considered an ideal Fortune 500 Company. Universally considered well managed, Gateway's CEO and founder, Ted Waitt, continues to imbue the company with the focus characteristic of a small startup company. The development of the YourWare:) program should help to drive sales and increase Gateway marketshare by decreasing consumer's reluctance to purchase a computer for fear that it will become obsolete too quickly. YourWare:) should also increase profits on computers that would be sold anyway because many YourWare:) customers pay double digit interest rates on their financed computers. Gateway Country stores should also help Gateway too further erode the marketshare of locally sold computers from companies such as Circuit City and Best Buy, by allowing customers to see their computer before they buy, which is very important to the novice computer user. Gateway offers a high quality product, which along with its unique cow-spot marketing theme, have established a strong brand for Gateway. Gateway consistently boasts the highest rate of customer loyalty, defined as customers who purchase another computer from the same manufacturer, in the industry. Gateway can be expected to generate 25% annual earnings growth. Considering the premium placed upon technology companies, an earnings multiple of 35 to 40 can be justified. Therefore, I have an 18 month price goal of $125 to $140.
-Marc Gersen
Note that the above are merely estimates and any equity investment entails the risk of loss