- After a tumultuous year and a half, the retail sector is heading into 2022 under some pressure.
- UBS analysts predict that wallet share is likely to shift from goods back towards services.
- They share 8 stocks they predict will perform well next year despite these factors.
Retail has gone through an incredible redemption arc over the last year and a half.
When the pandemic first began, retailers were plagued by a nosedive in foot traffic and forced to sit on mountains of inventory that they were unable to offload. Production and shipping obstacles bottlenecked global supply chains, exorbitantly increasing manufacturing costs. Dissatisfied employees left the sector in droves, creating a massive labor crisis as stores struggled to keep up with wage inflation in the scramble to find workers.
But the industry’s deus ex machina came in the form of stimulus packages. Suddenly consumers had money to burn, and stores could barely keep up with skyrocketing consumer demand. Profit margins rose as retailers were able to sell all of their stock at full price rather than rely on store sales and promotions.
Today, sales growth has plateaued since its spring heights, but spending is still elevated compared to pre-pandemic levels. According to the US Census Bureau, retail sales rose 0.7% in September to $625 billion, which is well in line with an economic recovery.
So where does retail go from here?
“A key debate heading into the year ahead is how will the sector generate meaningful sales growth in light of most of these retailers coming off an extended period of unprecedented demand,” said a team of equity research analysts at UBS led by Michael Lasser.
In a report from November 3, Lasser noted that consensus currently forecasts average sales growth of 6.7% in 2022. His team’s top-down analysis, which takes into consideration several different macroeconomic factors, revealed that “there’s a wide range of outcomes of demand for various hardline, broadline and foot retail categories in 2022.”
If the pandemic savings frenzy reverses, with the 33.7% personal savings rate in March 2020 – the highest in the 60 years the Fed’s been reporting it – declining back down to the five-year average of 6.5%, the team expects $900 billion of incremental spending to be unlocked. That money would drive all of the overall spending growth in 2022.
On the other hand, accumulated savings, such as from the accelerating equity market, wouldn’t make as much of an impact since savings are concentrated in higher income households.
The main takeaway, Lasser says, is that “spending on goods is likely to be under pressure next year.”
“Over the course of the pandemic, there was a reversal of the long-term trend of consumers allocating a larger portion of their spending to services instead of goods,” he wrote. “As the economy normalizes and services fully reopen, it is likely that the recent increase in the wallet share of goods will regress.” However, Lasser predicted that the Home Improvement, Auto Parts, and Beauty categories would see greater spending than others.
Lasser highlighted a stronger labor market, the potential for further support from the government, and higher inflation, which is historically correlated with positive retail sales growth, as potential upside support for the retail sector. For a downside scenario, Lasser pointed to a slower return of the labor force and flat salaries.
“Thus, we think it makes sense to stick with share gainers like Walmart (WMT), category recovery stories like Ulta (ULTA), or those levered to strong professional customer trends like Advance Auto Parts (AAP), O’Reilly Automotive (ORLY) and Home Depot (HD),” Lasser said.
To that end, Lasser and his team identified eight retail stocks to buy given the macroeconomic factors they considered. They’re listed below, along with each company’s ticker and market capitalization.
Market Cap: $4.4 billion
2. Advance Auto Parts
Market Cap: $14.5 billion
3. Floor & Decor
Market Cap: $15.3 billion
4. Home Depot
Market Cap: $393 billion
Market Cap: $168 billion
6. O’Reilly Automotive
Market Cap: $43 billion
7. Ulta Beauty
Market Cap: $21 billion
Market Cap: $422 billion