Could Inflation Actually Be a Good Thing for Retail?

Inflation, which is the decrease in the purchasing power of money, has been one of the main stock market headlines this summer, instigating bouts of volatility amidst the economic recovery.

In functioning free market economies, periods of inflation are normal. The cost of day-to-day economic goods and services gradually rise over time, but things get concerning when prices rise too quickly.

Economists use a variety of methods to track inflation, but the Consumer Price Index is the most commonly used in the U.S. The CPI charts fluctuations in the prices paid by consumers for food, housing, education, clothing, and other various services; the most recent reading showed the CPI advancing 5.4% in the 12 months through July.

Retail Impact

Companies across all industries tend to raise prices on their products to help offset any negative inflationary impacts, since a decrease in spending power reverberates all the way down the manufacturing line.

I’m sure you’ve noticed higher prices at the grocery store, at apparel retailers, at your local Target (TGT). But unlike past periods of inflation, consumers are flush with more cash than they’ve been in a long time, having saved more money than usual during the pandemic. And they want to spend, spend, spend.

Retailers are in a unique sweet spot right now. The pandemic thinned out the competition, forcing companies into bankruptcy, to reduce their store count, or to permanently close locations all over the country. Those left standing will likely experience greater pricing flexibility as shoppers return to stores (less competition, less options for consumers) in the mood to shop until they drop.

These retailers have also had the luxury of testing price hikes and resistance levels on both a market-by-market and on a consumer-by-consumer basis, seeing what works and what doesn’t, and what will ultimately bring on the most profits.

I’m not saying that inflation is all sunshine and roses for the retail industry—retail can be very finnicky, since you have to predict what consumers will want in the future and what they will be comfortable paying for those goods—but companies today are incredibly well-equipped to handle economic and consumer behavior changes. The rise of e-commerce and online shopping have provided crucial real-time data about what customers are buying, when they’re buying, and what the competition is up to. Inflation may end of being less of a burden for retailers this time around because of these factors.

Top Stock to Buy: LULU

Lululemon (LULU) has been a favorite retailer of mine for years now. Their products are my number one choice when I need to update my leggings and other activewear; their quality is consistently great; and in-store shopping is a relaxing experience.

Shares gained over 33% in the past three-month period as investors rotated back into growth stocks. Wall Street has also turned its attention back to LULU; Goldman Sachs (GS) recently put the retailer on its elite conviction list, rating the stock a Buy with a price target of $447 per share.

What I like most about Lululemon as a company is that it keeps executing on what it does best. Last year, as the world shut down and everyone stayed home, the desire to live comfortably hit an all-time high. We all bought sweatpants, sweatshirts, and loungewear, and many of us turned to LULU for these clothing items.

In response, the retailer improved its digital distribution channel—it already had an easy-to-use app and website—and loyalty and brand awareness, which was very strong pre-pandemic, solidified even more.

2021 is set to be a strong year for Lululemon, even with the threat of inflation lingering on the sidelines. Consumers like myself are already familiar with Lululemon’s mid-luxury prince point, so if the price of my favorite tank top or pair of leggings increases a bit, it won’t deter me from making that purchase.

Management is predicting revenue to be between $5.825 billion and $5.905 billion for the year, which reflects 33% growth at the midpoint, now that stores are back open and customer traffic is thumping. The company could see even more gains as it continues to expand geographically and launches new clothing categories as well.

The stock is still expensive at 52X forward earnings, but shares are at an attractive discount compared to valuation levels recorded in Q1 of this year (nearly 75X).

If you’re looking for a retail stock with many different long-term growth catalysts in its holster, put LULU on your shortlist.

 

Disclaimer: I own TGT and GS in the Income Investor portfolio.

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