Gap, TJX and Coach to deliver strong sales during holiday season

Holiday season is the most lucrative sales period for retailers. The second most important season is the ‘back-to-school’ season in the third quarter when shoppers stock up on clothing and school supplies for their children.

Historically, the correlation between the sales growth of the two periods is high as the back to school season tends to capture customers' willingness to buy products which then often correlates with holiday season sales. Using such correlations we should expect the clothing and accessory category to outperform others (table 1) this holiday season.

During this year's ‘back-to-school’ season, the clothing and accessory segment increased its sales by 5.4 percent over last year's. With a correlation of 0.716 to the holiday season, clothing and accessories should have a promising outlook.

Hot prospects in Q4
Looking at several large US clothing and accessory retailers that have reported same-store-sales (SSS) including the months of August and September, the prime season of ‘back-to-school’, we see a few hot prospects for Q4, assuming the correlation holds for this year’s holiday season.

One stock sticks out negatively -  Abercrombie & Fitch (NYSE:ANF). The company is struggling to increase its comparable sales, with most of its revenue growth coming through expensive expansion. Due to significant mark-up on its products the company’s gross margins look good, but its high operational expenses are reflected in thin net margins.

On the positive side most of the other clothing and accessory retailers could have solid holiday sales. As my colleague Matt Bolduc has pointed out a few times (Post-1, Post-2, Post-3), Coach (NYSE:COH) is a very hot prospect, not only for the holiday sales but also for the longer term. Coach has done well historically growing its sales, has very strong margins and comes at a lower price than other stocks on the list.

Both TJX (NYSE:TJX) and Gap (NYSE:GPS) have seen a strong momentum in demand for their products. Both companies have continuously delivered positive earnings and sales surprises to the market this year, and are highly likely to repeat such in the fourth quarter. Gap is currently the highest performer of the apparel category and analysts still believe there is a potential for another 12 percent upside.

Less likely to perform
Based on the correlation pattern, the bottom performers for the fourth quarter are likely to be the department stores. This category holds stocks like JC Penney (NYSE:JCP), Macy’s (NYSE:M), Kohl’s (NYSE:KSS) and Sears (NASDAQ:SHLD). I have previously highlighted JCP as a struggling candidate for the holiday season as its new pricing strategy continues to confuse customers who seem to be doing their shopping elsewhere. Kantar Retail recently presented a study showing that nearly 10 percent of J.C. Penney’s shoppers have moved elsewhere, benefitting Macy’s, Kohl’s and even Wal-Mart (NYSE:WMT).

Industry's earnings outlook looks promising in Q4
Overall, retail is expected to deliver strong earnings growth in Q4. With apparel retail being at the top, chart two illustrates even more strongly that this segment is expected to be a strong performer in fourth quarter.

So, if the strong correlation as well as analysts’ earnings expectations in Q4 play true, the industry will trade at higher levels. There are two ways to play this, either buy an ETF on the retail industry or pick your own stocks. Personally I would stick to stock picking to avoid the ‘Abercrombies’ of the industry. To me, Gap, TJX and Coach look the most promising ones.