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By Bridget Weishaar | 07-10-2017 02:00 PM

3 Factors Driving Retail Stocks' Decline

Too many stores, e-commerce, and a shift in demand have been weighing on the sector, says Morningstar's Bridget Weishaar.

Bridget Weishaar: We see three factors driving performance for retail stocks. 

First is mall exposure. We believe the U.S. is very overstored with almost 24 square feet of retail space per person. That compares to 16 in Canada and 11 in Australia. This means the U.S. has more than double every other country except Canada. We think companies are only in the early stages of rightsizing the store base and fear that companies with large store bases could see shrinking square footage over the next several years. 

The second factor driving retail performance is e-commerce adoption. With comparable store sales declining at many retailers and e-commerce growing in the double digits, we see Internet penetration reaching 30% for apparel retailers in the next five years and over 50% in the long term. This will likely further complicate the overstorage issues we just discussed.

Finally, we see shifts in demand. Apparel demand has fallen with only 1% growth in 2016 versus 3% growth for the total retail sector. We think that demand is shifting to categories such as home goods and healthcare. Therefore, we favor apparel companies with cost advantages that allow for selling at more attractive price points or that have responsive supply chains that can adjust for varying levels of demand. Two stocks we like right now based on valuation include TJX and Hanesbrands.

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