The improving U.S. economic scene, some early tentative signs of a turnaround in the labor market, and pent-up demand held down by the recession have come together to perk up the retailers. Evidence of these favorable trends has been seen in comp sales, though the improvements are far from uniform.

Recovery still remains fragile and requires a boost from a sustained and significant recovery in jobs creation and income growth. In the end, it will be the turnaround in the jobs and income picture that will outweigh other drags, such as tighter credit availability and new credit regulation.

Coming out of the downturn, consumer shopping preferences also appear to be shifting. There is clear evidence that consumers now prefer online shopping for electronics and other categories. This has prompted retailers to beef up their online presences. J.C. Penney Company, Inc. (JCP) has been in the process of refreshing its website functionality due to continued migration to online shopping.

In addition to online, Off-mall value specialty stores, coupled with small-ticket discretionary categories, also remain well positioned, at least in the near term. Value-focused mass retailers are also expected to hold up well, including super-centers and warehouse clubs.

The National Retail Federation expects that while the retail environment will remain difficult, the improving economy will bring in some relief in terms of positive sales gains. Retail store chains have been able to post improving sales trends by cutting down inventories and offering attractive discounts to customers.

The current business momentum seen in companies such as Big Lots, Inc. (BIG), Family Dollar (FDO) and Gap Inc. (GPS) remains favorable with the rise in sales of discretionary items, comparable-store sales growth, unit acceleration due to a softer real estate market, a broad vendor base, a new loyalty program as well as enhancement of shareholder return.
 
Many companies have been delivering solid comparable-store sales growth such as Gap, which has been witnessing positive trends in comparable-store sales at all North American divisions. After flat comps in the third quarter and a 2% increase in the fourth quarter of fiscal 2009, comparable-store sales increased 4% in the first quarter of fiscal 2010.

Ann Taylor (ANN) also posted comps increase of 16.4% year over year in the first quarter of 2010.  A number of companies have lifted their earnings outlook; the notable ones being Gap and Macy’s (M).

In addition to the improving macro backdrop, the easy comparisons from the prior year should also put this year’s performance in a better light. The sustainability of the momentum, however, will rest squarely on the continued economic recovery and improvement in the job market. This will ultimately boost consumer confidence and disarm prudent discretionary spending.

OPPORTUNITIES

Many of the apparel retail chains have benefited even in the tough macro economic environment. In this group, we prefer the following companies:

Gap, Inc. (GPS), the largest U.S. clothing chain, delivered solid top-line and earnings results for first-quarter 2010. The company is expected to continue to deliver strong sales as comps comparisons remain easy throughout the year. GPS’ size and buying power as compared with other retailers help it to tackle higher costs. Also, the turnaround story in the U.S. has helped the company to build a strong position in order to expand overseas and online.

Limited Brands, Inc. (LTD), a specialty retailer of women’s intimate and other apparel, beauty and personal care products, represents a story with positive comps, margin recovery and strong international growth opportunities. The company’s international twist includes an expansion plan in Canada. The company has been able to showcase the potential of its brand internationally through various initiatives.

WEAKNESSES

Some of the companies, however, have been more than hit by the lackluster macro environment. In this group, we discuss American Eagle Outfitters and Home Depot.

American Eagle Outfitters, Inc. (AEO) reported earnings drop of 55.0% in the first quarter of fiscal 2010. Inventory levels remain high and the pricing environment remains competitive. High inventory levels as compared with peers are an obstacle to out-performance. However, the company’s plan to further expand internationally will help to bolster its growth.

The Home Depot, Inc. (HD), one of the world’s largest home improvement retailers, reported better-than-expected, first-quarter results. However, the company faces fierce competition from various global and regional competitors. Also, exposure to adverse foreign currency translations also puts a question on the future prospects of the company.Zacks Investment Research