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Why Macquarie Group Ltd is suddenly bullish about retail stocks ahead of the reporting season

Our listed retailers have gone though some of the most challenging times in recent history but 2018 will mark a turning point for the sector, according to the analysts at Macquarie Group Ltd (ASX: MQG) who have an “outperform” view on the consumer sector.

But not all in the sector have been underperforming. Those selling staples like supermarket giant Woolworths Group Ltd (ASX: WOW) and even its weaker rival Metcash Limited (ASX: MTS) have delivered gains over the past year.

It is those in the discretionary retail space that have been suffering. Macquarie noted that these stocks have suffered a hefty price-earnings derating of 15.3%. A derating means investors are willing to pay less for a stock for every dollar of earnings the company produces.

There are a number of reasons why investors are not willing to pay more for these stocks. The rapid growth of online shopping is posing a structural challenge to these brick and mortar retailers and the arrival of US online shopping behemoth Amazon.com has further hurt sentiment.

There is also the issue of falling prices across a number of categories due to competition and other factors that is buffeting the sector. Price deflation is great for consumers but bad for retailers.

There are also cyclical challenges for discretionary retailers. Wage growth is practically non-existent, a sombre outlook for home prices and record high household debt are forcing consumers to be more cautious on spending.

But Macquarie believes the bad news is more than priced in with our listed retailers trading at around a 13% discount to the market compared to the long-term average of around 4%.

As I had flagged earlier this year, trading conditions for our retailers are actually improving. We don’t want to get ahead of ourselves here but there are reasons to feel more optimistic this year as economic growth in Australia and the world is expected to accelerate.

However, Macquarie thinks you will only find good buys among the more beaten down consumer stocks. This means it favours Wesfarmers Ltd (ASX: WES), the owner of Coles supermarkets, over Woolies as Wesfarmers is trading at a discount even though its supermarket business accounts for only a third of its group earnings before interest and tax versus 77% for Woolies.

The broker also likes JB Hi-Fi Limited (ASX: JBH) as the market is still pricing in an earnings downgrade for the electronics and home appliance retailer and ignoring the potential upside from its acquisition of The Good Guys chain.

Another value stock in the sector that gets the broker’s “buy” tick is beverages company Coca-Cola Amatil Ltd (ASX: CCL) but travel agency Flight Centre Travel Group Ltd (ASX: FLT) gets a thumbs down as the stock is too expensive following its recent re-rating from a positive trading update.

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Motley Fool contributor Brendon Lau owns shares of Macquarie Group Limited. The Motley Fool Australia owns shares of and has recommended Flight Centre Travel Group Limited and Wesfarmers Limited. The Motley Fool Australia has recommended Coca-Cola Amatil Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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