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These Retail Stocks Look Undervalued, but Consider This Before You Buy!

In Canada, January retail sales fell by 0.3%, in what is the third consecutive month of declines and below expectations performance.

In the U.S., retail sales fell by 0.2%, after a 0.7% increase in January, and a roughly 2.2% increase in the last year.

So we can see that growth is slowing pretty significantly.

Volatile markets, weakening housing markets, and most importantly, record high debt levels are taking their toll.

I think it’s fair to say that we cannot expect a consumer-led economic growth engine in the years ahead like we have seen for the last many years.

With this in mind, let’s look at two retail stocks that appear undervalued. Is there really value there or is it just a head-fake that will bite us in the end if we buy now?

Spin Master Inc. (TSX:TOY)

Spin Master rose from humble beginnings to a company that now has 28 global offices and sales in over 60 countries.

With a strong and innovative history that has benefited from a collaborative model that provides access to a global network of inventors, Spin Master has produced some of the most popular toys in recent years.

From 2014 to 2018, revenue increased at a compound annual growth rate (CAGR) of 18%, and adjusted net income increased at a CAGR of 24.5% while generating strong free cash flows and maintaining little debt.

But the stock is down 36% from 2018 highs, and is now trading at a price earnings ratio of a still high 22 times this year’s consensus estimate, as recent results show a slowing, with revenue declining 4.6% in the latest quarter, down from double-digit sales growth numbers that even surpassed 20% in the last couple of years.

Another area of concern is the fact that the company’ business is largely dependent on successfully coming up with the next new toy that consumers will want, which can be based on consumer fads.

Given this fact, the company has been working hard to prolong the shelf life of their toys through marketing, their broadcast relationships, and the development of global entertainment properties.

I don’t believe that TOY stock is undervalued enough to compensate for these risks.

Sleep Country Canada Holdings Inc. (TSX:ZZZ)

Sleep Country stock is down almost 50% from 2018 highs as its market has been turned upside down by intense online competition.

The stock is now trading at 10 times earnings in what I believe is a very attractive buying opportunity.

A strong balance sheet, strong free cash flow generation ($41 million in 2018, or 6.5% of revenue), and a solid competitive positioning in its very fragmented niche market that is ripe for continued consolidation and market share gains by Sleep Country (which holds an over 20% market share currently) are drivers for the stock.

While Sleep Country is not immune to the increasingly difficult retail environment, the stock is very cheap and company-specific fundamentals are good, so this retailer is a good bet.

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Fool contributor Karen Thomas has no position in any of the stocks mentioned. The Motley Fool owns shares of Spin Master and has the following options: short April 2019 $48 calls on Spin Master.

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