Luxury stocks fall from favor even though confidence holds

Bloomberg NewsOctober 22, 2013 

NEW YORK -- Upscale U.S. retail stocks have fallen out of favor with investors even though high-income Americans are generally positive about the economic outlook.

Shares of Nordstrom have lagged behind the Standard & Poor's 500 Index by about 12 percentage points since July 1, while Ralph Lauren Corp. has trailed the benchmark index by almost 14 percentage points. As these stocks have weakened, the S&P 500 has rallied 8 percent, closing at a record high Oct. 18.

This shows that some analysts and investors have become "too pessimistic" about these retailers' earnings and customer base, said David Yucius, who oversees $250 million in assets as president of Aurora Investment Counsel Inc. in Atlanta. Their concern may be misplaced because people who shop at these stores seem to be doing "just fine," and there isn't evidence to suggest a "decline or even stress" among these consumers.

Sentiment among Americans earning more than $100,000 averaged 16.7 in the four weeks ended Oct. 13, up from 15.2 in the four-week period ended June 30, as measured by the Bloomberg Consumer Comfort Index. While it fell to 14 from 19 in the most recent survey, released Oct. 17, this remains the only income group with a positive reading.

These consumers -- the primary customer base of "affordable luxury" companies such as Coach, Tiffany & Co. and Michael Kors Holdings -- aren't necessarily "immune to everything," said Paul Lejuez, a New York-based analyst at Wells Fargo & Co. There has been a "wallet-share shift" as many have chosen to spend their money on cars, electronics or home furnishings instead of these retailers' products, he said.

While this has contributed to weaker sales and earnings forecasts, Lejuez said he maintains "market perform"

recommendations on Seattle-based Nordstrom and Tiffany and Coach, both in New York.

Slower sales earlier this year for these companies were attributed in part to higher taxes for wealthy Americans. On top of an increase for all employees in the tax that funds Social Security benefits, there's also a new 0.9 percent surtax on wages and 3.8 percent added tax on investment income for individuals making more than $200,000 a year and for couples making more than $250,000.

Additionally, Congress set the top income-tax rate at 39.6 percent on taxable income above $400,000 for individuals and $450,000 for couples, compared with 35 percent last year.

The changes -- along with budget battles in Washington and rebounding automobile and home sales -- serve as a "headwind" to discretionary spending at luxury retailers, said Walter "Bucky" Hellwig, who helps manage $17 billion at BB&T Wealth Management in Birmingham, Ala. The lag in their stocks since the summer is a "very good barometer" of the pessimism investors have for their customers' spending ability, he said.

Americans aren't as enthusiastic as Asian consumers about luxury shopping, while the European market remains sluggish, Yucius said, adding that "cooling" growth in China presented another threat to these companies' sales.

As a result, analysts have reduced their expectations for several of these retailers. Earnings for Nordstrom will be $3.68 a share in its current fiscal year, down about 7 percent from estimates in January, according to the consensus of analyst forecasts compiled by Bloomberg. The consensus for New York- based Ralph Lauren also is lower: $8.74 a share now, down about 5 percent from January.

Ralph Lauren has been underperforming the market since early 2012, reversing a four-year uptrend, as investors are "pulling money out of it faster than the S&P 500 Index," said Jim Stellakis, founder and director of research at Greenwich, Connecticut-based research company Technical Alpha Inc. Similarly, the relative performance of Nordstrom also has been weak this year, though the sell-off hasn't been "as severe."

Weakness in these stocks and the lower analyst earnings estimates reflect a U.S. economy that's still "so anemic," said Tim Ghriskey, chief investment officer of Solaris Asset Management LLC and co-founder of the New York-based Solaris Group LLC, which oversees more than $1.5 billion.

The world's largest economy will grow at a 1.9 percent annual pace in the third quarter, compared with 2.8 percent a year earlier, according to the median forecast of economists surveyed by Bloomberg from Oct. 4 to Oct 9, during the 16-day partial government shutdown.

That's why investors should monitor earnings from these retailers to see if there's further deterioration in consumption or if market-share losses are to blame for weaker management forecasts, Ghriskey said.

Coach is scheduled to release fiscal first-quarter results Tuesday. Ralph Lauren, Michael Kors, Nordstrom, Saks Inc. and Tiffany are slated to announce earnings in November.

If these companies report another quarter of weakness, that could signal their core customers are struggling, Ghriskey said, adding this is one reason his firm doesn't currently hold any of these stocks. As more competitors try to sell to a base of consumers he doesn't see growing, it's creating an unfavorable environment for both margins and earnings.

The impact varies, however, as competitive dynamics mean there are the "haves and the have nots" in this industry, Yucius said. "The whole ship isn't sinking, it's a matter of which brand is winning the fashion trend of the moment."

Coach, for example, has lost market share to Hong Kong- based Michael Kors. Relative to the S&P 500, investors have been pulling money out of its stock since 2012 and they haven't stopped, Stellakis said. Meanwhile, short interest has "exploded," from 10 million shares in January to about 20.7 million as of Sept. 30, he said, citing data compiled by Bloomberg -- underscoring that investors don't see "anything positive" with the stock.

In a short sale, traders sell borrowed stock on the assumption the price will decline, allowing them to make money by buying it back at a lower price.

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