The hardlines and grocery retail stocks to own in 2024, according to UBS

Looking to 2024, UBS is expecting subpar returns for the stocks in the hardline, broadline and food retail sectors this year. While the firm is not outright bearish, it thinks the risk reward for many of these names isn’t that compelling. Nonetheless, UBS believes that a pullback in several of the names would present opportunities. The firm’s top ideas are Target (TGT), Dollar Tree (DLTR), Dollar General (DG), and Tempur Sealy (TPX).

2024 OUTLOOK: The firm’s advice for this year is to maintain select exposure to a blend of defensive and cyclical retailers. UBS expects subpar returns for the stocks in the hardline, broadline and food retail sector in 2024, and thinks the risk-reward for many of these names aren’t that compelling. Plus, there are clear and obvious risks on the horizon that are likely to hang over these stocks, it argues. Still, the firm believes that a pullback in several of the names would present opportunities. As a result, it advocates it’s best to be discerning when investing in this group.

Looking out over the near-term, the sector faces a sales slowdown from the moderation in inflation across important product categories. Plus, there’s less excess consumer savings to drive demand, the firm says. Finally, the shift from goods to services still probably poses a 150bp-250bp headwind to retail sales this year. Focusing on the longer-run, UBS thinks this year will bring positive signs regarding large-retailer market share consolidation, big-ticket purchase cycle normalization, alternative profits progression, and automation/technology deployment ascension.

TOP IDEAS: The firm’s top ideas are Target, Dollar Tree, Dollar General and Tempur Sealy as it believes these retail stocks offer the best combination of reasonable valuations, company specific drivers and the ability to perform well in different economic backdrops.

For Target, the firm estimates that sales and profits will improve this year. The consensus is forecasting a 1% comp this year and $9.12 of EPS. UBS thinks those are achievable, putting the company on pace to do even better in 3025. Target has the ability to recover 150 bps-plus of margin from improving shrink, supporting its profit potential independent of its sales outlook. Plus, the stock is trading at 15.9-times, which is below its 5-year average of 17.1-times, the firm argues.

For Dollar Tree, UBS believes the stock is embedding very little value for the Family Dollar business, which is a source of upside. This segment is on pace to generate only $110M of profit in 2024 out of nearly $2.1B in total. Rationalizing unprofitable stores will be a visible way to improve this segment. The firm notes that the core business should sustain its comp momentum due in part to an increase in multi-price point products. Plus, it should see outsized profit gains from cost deflation.

For Dollar General, UBS thinks its comp momentum will accelerate into 2024. Its recent investments should provide returns, minimizing the need for a substantial increase in this spend. The firm is conservatively projecting that Dollar General’s OM reaches 6.5% in 2025, well below its 20-year average margin of 8.3%.

For Tempur Sealy, the firm sees several sources of potential upside for the stock. First, units could inflect higher in 2024 given this industry-wide metric is below 2019 levels. Even if that key driver doesn’t recover, UBS believes Tempur Sealy should generate 10% EPS growth driven by gross margin gains as it benefits from a moderation in input costs. Finally, the multi-year outlook is compelling as it either completes the Mattress Firm deal or it repurchases a substantial amount of stock, the firm argues.

TARGET CHANGES: UBS maintains its ratings for each of its stocks under coverage. That said, the firm is changing several price targets, including Buy-rated Tempur Sealy’s to $63 from 450, Buy-rated Chef‘s Warehouse’s (CHEF) $36 from $34, Buy-rated Academy Sports and Outdoors (ASO) to $81 from $74, Buy-rated Lowe’s (LOW) to $250 from $240, Buy-rated Five Below’s (FIVE) $270 from $240, Buy-rated O’Reilly Automotive’s (ORLY) to $1,125 from $1,075, Buy-rated Home Depot’s (HD) $390 from $355, Buy-rated Wayfair’s (W) to $75 from $65, Buy-rated Floor and Decor (FND) $130 from $100, Neutral-rated Mister Car Wash’s (MCW) to $10 from $6.50, Neutral-rated Dick’s Sporting’s (DKS) to $142 from $130, Neutral-rated Best Buy’s (BBY) to $82 from $76, Neutral-rated RH‘s (RH) to $300 from $280, Neutral-rated Tractor Supply’s (TSCO) to $220 from $215, Neutral-rated Kroger’s (KR) to $50 from $52, Neutral-rated Advanced Auto Parts’ (AAPL) to $68 from $62, Neutral-rated Petco’s (WOOF) to $3 from $2.75, and Neutral-rated ODP‘s (ODP) to $61 from $56.