Zacks senior analyst
Sean P. Smith covers several special situation companies in the consumer discretionary space. Today we check in to see how the slowing economic growth is impacting consumer spending within various sectors of his coverage list.
There are many concerns on the Street related to a slowdown in consumer spending. How has this theme impacted some of the consumer discretionary stocks that you follow?
To this point, the slowdown has played out about as expected, with companies providing products or services that are deemed to be the most discretionary being hit hardest. For example,
Pool Corporation (POOL), which is the world's largest wholesale distributor of swimming pool supplies, equipment, and related products, has been negatively impacted by and the pressures on consumer spending. The company posted a loss in Q1 versus a profit in the year ago period.
We are currently projected a slight decline in year-over-year revenues in 2008, along with a decline in earnings per share of more than 5%, despite a reduced share count versus the year-ago period. The maintenance side of the business is holding up well, as consumers that have already installed a pool are more than likely going to use it. The new installation side of the business has suffered, however, in large part due to the downturn in the housing market.
Another stock that is feeling the impact of economic pressures on the consumer is Shutterfly (SFLY), a web-based company that provides online photo sharing services and personalized products such as cards, calendars, and photo-books. The company generally runs at a loss through the first three quarters of the year, before becoming profitable in the fourth quarter.
Like many companies relying upon the consumer, SFLY is holding out hope that macroeconomic conditions improve by year-end. This uncertainty is evident in management's annual guidance range, which calls for earnings between $0.30 and $0.50 per share. The low end of the range would represent a decline of more than 20% compared to last year's earnings, while the high end of the range would represent an increase of more than 30%.
What about companies that seem to fall within a grey area between 'discretionary' and 'necessity'? Have their operating results held up any better?
For the most part, they have. These stocks can even spur a debate as to what it actually means to provide a discretionary service.
Regis Corporation (RGS), for example, owns, operates and franchises hair and retail product salons, and is the largest company in the hair care industry. Certainly, haircuts are a necessity item in the long-run. The timing of a haircut, however, can be viewed as discretionary in the short run. With economic pressures on the consumer, some customers that may have previously scheduled haircuts once a month may push that frequency back to once every six weeks, for example.
While we like the company's overall positioning, our Hold rating in the short-term is based upon the difficult operating environment that Regis currently faces. We project that fiscal 2008 earnings will be down slightly year-over-year, before rebounding in 2009.
Another company on the fringe between discretionary and necessity is Town Sports International (CLUB), which owns and operates fitness clubs in New York, Boston, Washington D.C. and Philadelphia. The shares had declined steeply in recent months under the rationale that in an economic downturn, gym memberships might be among the first expenditures to be cut by consumers looking to save money.
The operating results have actually held up well, however, and the shares climbed more than 25% in one day last week, after the company reported solid earnings results. In today's society, it seems that many of the company's customers do not, in fact, view their gym memberships as purely discretionary items. That's not to say that companies like CLUB should by any means be considered 'staples,' but we do think that the resiliency should be noted.
You also cover the major cruise lines -- companies that seem to provide the ultimate discretionary service. How have they been impacted by the slowing economy?
To this point both Royal Caribbean (RCL) and Carnival Corporation (CCL) and Carnival plc (CUK) have held up well. Although their service is without a doubt a discretionary item, many consumers would prefer to cut back on other day-to-day expenditures as opposed to forgoing an annual vacation. Additionally, the perceived value offered by the cruise lines remains high, relative to other potential vacation trips.
We are projecting revenue gains for both companies in 2008. At this point, the impact of high fuel prices on the companies' bottom lines is a larger issue than consumer demand. We continue to prefer RCL, based primarily on valuation.
