These 2 Retail Stocks: Analysts Say, "Buy the Dip!"

Key Points

• Retail stocks are significantly lagging the S&P 500 year-to-date.
• Consumers still limit purchases of big-ticket items so value retailers that have exposure to the essentials may be better positioned to outperform.
• Target is expected to record profit growth for the first time since the fourth quarter of 2021.
• Dollar General is trading at 16x this year’s EPS estimate, significantly below its five-year historical average P/E of 21x.

Few industries were as hard hit as retail during last year’s market selloff. Rising prices and interest rates caused shoppers to curtail spending. From supermarkets to clothing stores, retailers rang up mostly disappointing financial results. The S&P Retail Select Index dropped 33%.

This year has been more of the same. While inflation has cooled, prices and credit card rates are still up compared to 2022 levels. E-commerce activity remains stagnant. As a result, retail stocks (3%) are significantly lagging the S&P 500 (15%) year-to-date. 

According to Wall Street, it may be time to start putting retail stocks in the shopping cart — but very selectively.

With consumers still limiting purchases of big-ticket items like electronics, value retailers that have exposure to the essentials (food, cleaning supplies, hygiene products) may be better positioned to outperform. Discount stores like Costco, Walmart and Ollie’s Bargain Outlet are among this year’s retail winners. Others have been slower to recover, but analysts say this has created some bargain opportunities.

So as shoppers begin to pick up sour cream and guacamole for summer events, Wall Street suggests grabbing these two retail stock dips. 

Is Target Stock Oversold? 

Target Corporation NYSE: TGT fell to a nearly three-year low last week as investors continued to exit the stock after tepid second quarter guidance. Due to ongoing macro headwinds, management is anticipating negative comparable store sales growth in the current quarter. 

The market has ignored the silver lining, which is that the retailer is expected to record profit growth for the first time since the fourth quarter of 2021. Facing an easier comparison, earnings per share (EPS) are forecast to jump 310% year-over-year based on the consensus estimate. Sequential profit growth is anticipated from there as the holiday shopping season kicks into gear. Along with a mix of cost cutting and efficiency initiatives, it is this longer term outlook that has Wall Street increasingly optimistic about a turnaround.

Last week, Bernstein called the Target selloff a buying opportunity, suggesting the risk-reward tradeoff is now “overwhelming to the upside.” The analyst gave the retailer a Street-high $183 price target that implies 37% upside from Friday’s close. If the stock can continue to bounce off long-term support at $126.75, the distance to the long-term resistance level of $163.29 would indeed be significantly higher than the downside.

Another reason to like Target here is that the company just announced an increase in its quarterly dividend. Although a modest two-cent increase, it marks the 52nd straight year that the retailer has hiked its dividend. Our two cents — the new dividend gives the stock a 3.3% forward yield that’s well above the sector average.  

Is the Dollar General Selloff an Opportunity?

On June 1, Dollar General Corp. NYSE: DG gapped down almost 20% to its lowest level since April 2020. The discount retailer missed first quarter expectations and slashed its full-year outlook. CEO Jeffrey Owen noted that the company’s lower income customer base is being pressured by higher food prices, the expiration of pandemic Supplemental Nutrition Assistance Program (SNAP) increases and the end of the child tax credit.

J.P. Morgan thinks the selloff is overdone. Last week, the firm added Dollar General to its analyst focus list and gave it a $187 price target. Barclays, on the other hand, drastically lowered its target from $213 to $165. 

Most retailers have struggled to grow revenue since recording abnormally high, pandemic-led growth in 2021. Dollar General isn’t one of them. It has posted revenue growth in each of the last seven quarters despite having a more economically-sensitive customer base than most in the industry. This suggests that as inflation continues to cool and economic conditions improve, financial results will only get better. 

In the meantime, a high concentration of essential goods on Dollar General shelves should keep store traffic healthy. In Q1, consumables sales (which account for around 80% of total sales) were up 9%. 

Dollar General is trading at 16x this year’s EPS estimate, significantly below its five-year historical average P/E of 21x. Toss in a 1.4% dividend and this discounted dipper may prove a valuable consumer rebound play.