Top managers are divided over what looks like a bargain and what doesn't.
With the holiday shopping season just around the corner and some recent signs that consumers are perking up, the spotlight has been on retail companies. Retailers have the most to gain or lose from shifts in consumer spending, and the latest trend has been positive after a dismal dive last year for stocks in the sector. Last week's retail-sales report was encouraging, raising hopes that the bleak conditions that have enveloped these companies for so long might be lifting.
Yet, the top managers we follow are divided on the sector's prospects. We looked across our domestic-equity Fund Analyst Picks to see how that group of respected and seasoned managers had invested in restaurants, clothing stores, and other categories of retailers.
Several of our favorite funds such as Royce Premier RYPRX, Osterweis OSTFX, Columbia Value & Restructuring EVRAX, Artisan Mid Cap Value ARTQX had little to no money invested in retail companies while others such as Vanguard Primecap VPMCX, T. Rowe Price Mid-Cap Value TRMCX and Vanguard Explorer VEXPX held moderate amounts.
Yet another group had piled in with more significant stakes. As of their last public portfolios, the following five domestic-equity Analyst Picks stood out for their hefty positions in retail stocks.
Buffalo Mid Cap BUFMX
This fund looks for companies poised to benefit from demographic trends while also researching company fundamentals. Of our picks, it provides the straightest shot and most meaningful exposure to a diverse bundle of retailers. It owns several clothing stores such as Abercrombie & Fitch ANF, Polo Ralph Lauren RL, Urban Outfitters URBN, and Chico's CHS, which all face constant pressure to hit the ever-changing fashion trends. Yet another portion of the portfolio is invested in a variety of retail outlets including troubled organic grocer Whole Foods WFMI, luxury jeweler Tiffany & Co. TIF, and PetSmart PETM.
Earnings momentum is the name of the game here, and the team at Brandywine has clearly seen potential in retail stocks with a discount theme. As of June 30, the fund held about 15% of its assets in retailers that cater to bargain hunters like TJX Companies TJX, owner of apparel chain TJ Maxx, and in a slug of auto-parts retailers like AutoZone AZO, which they think should benefit from a slowdown in new auto purchases. Brandywine focuses on companies it thinks will beat Wall Street analysts' earnings expectations in the near term. Its research approach lends itself well to the retail industry because the fund's large team of analysts conducts investigative research that taps the knowledge of suppliers, customers, and competitors. That often helps them stay on top of shifting trends in the fickle retail sector. While Brandywine's overall returns can lag peers in the short term at times, their retail bets in 2009 have generally risen in the double digits for the year to date. PAGEBREAK
Unlike Brandywine, a long-term view and deep dive into a company's financial statements drive the Clipper portfolio. And here is an example of how investors should use caution before interpreting a fund's high stake in a certain sector as a sign the manager thinks highly of every stock in that field. For Clipper's substantial stake in retail turns out to consist of one company: Costco COST, which gets a whopping 11% of assets. Managers Ken Feinberg and Chris Davis like Costco's healthy balance sheet, strong competitive position, and ability to generate enough cash to avoid tapping the credit and equity markets for capital. The duo has long liked Costco's management and finds the firm's business model and client base attractive. The management duo is responsible for running this fund along with Selected American Shares SLADX and David NY Venture NYVTX, focus on stock-specific research, and aim to purchase companies for significantly less than their assessment of worth.
Sequoia held 29 stocks at the end of June. Six of them were retail companies. That is not a bet on the industry. In fact, in a shareholder letter penned at the end of the first quarter, the managers pointed out that they had reduced their exposure to consumer discretionary firms and were biased toward continuing to cut back. However, they continue to like companies that help consumers save money--which is the case with the fund's holdings including TJX Companies, Walgreen WAG, and Target TGT. Management thinks those firms will have an edge in an environment that has driven consumers to be more frugal.
Oakmark I OAKMX
McDonald's MCD, Wal-Mart WMT, Walgreen, Best Buy BBY, and Kohl's KSS represent a good chunk of Oakmark's retail stake. It is not a broad bet on all types of retailers--note how manager Bill Nygren is leaning toward those stores that offer low prices to cash-strapped consumers--nor does Nygren seem to consider the retail stocks among his highest-conviction picks. In fact, his more concentrated charge Oakmark Select OAKLX only owned eBay EBAY and Best Buy and thus had a smaller overall position in the sector. But Nygren does like to buy what he considers high-quality companies dominant in their fields when he can get them for decent prices. So at Oakmark Fund he pounced on a number of such opportunities available among the retail giants in recent years.
Karen Dolan is Morningstar's director of fund analysis.