Retailers are overhauling their operations as technology redefines the shopping experience. But many seem to be moving too slowly as their demand is lagging, causing the industry to underperform the market - over the past six months, retail stocks have shed 5.8%. This performance is a noticeable divergence from the S&P 500’s 5.8% return.

A cautious approach is imperative when dabbling in these companies as many will light cash on fire by opening new locations without the proper justifications. Keeping that in mind, here are three consumer stocks we’re passing on.

Lithia (LAD)

Market Cap: $8.06 billion

With a strong presence in the Western US, Lithia Motors (NYSE: LAD) sells a wide range of vehicles, including new and used cars, trucks, SUVs, and luxury vehicles from various manufacturers.

Why Do We Think Twice About LAD?

1. Lagging same-store sales over the past two years suggest it might have to change its pricing and marketing strategy to stimulate demand
2. Widely-available products (and therefore stiff competition) result in an inferior gross margin of 15.9% that must be offset through higher volumes
3. High net-debt-to-EBITDA ratio of 7× increases the risk of forced asset sales or dilutive financing if operational performance weakens

Lithia is trading at $309.78 per share, or 8.7x forward P/E. Check out our free in-depth research report to learn more about why LAD doesn’t pass our bar.

Petco (WOOF)

Market Cap: $1.06 billion

Historically known for its window displays of pets for sale or adoption, Petco (NASDAQ: WOOF) is a specialty retailer of pet food and supplies as well as a provider of services such as wellness checks and grooming.

Why Are We Out on WOOF?

1. Weak same-store sales trends over the past two years suggest there may be few opportunities in its core markets to open new locations
2. Earnings per share have dipped by 41% annually over the past four years, which is concerning because stock prices follow EPS over the long term
3. 8× net-debt-to-EBITDA ratio makes lenders less willing to extend additional capital, potentially necessitating dilutive equity offerings

Petco’s stock price of $3.89 implies a valuation ratio of 27.4x forward P/E. If you’re considering WOOF for your portfolio, see our FREE research report to learn more.

Walgreens (WBA)

Market Cap: $10.03 billion

Primarily offering prescription medicine, health, and beauty products, Walgreens Boots Alliance (NASDAQ: WBA) is a pharmacy chain formed through the 2014 major merger of American company Walgreens and European company Alliance Boots.

Why Are We Hesitant About WBA?

1. Large revenue base makes it harder to increase sales quickly, and its annual revenue growth of 3.8% over the last six years was below our standards for the consumer retail sector
2. Commoditized inventory, bad unit economics, and high competition are reflected in its low gross margin of 17.7%
3. High net-debt-to-EBITDA ratio of 6× could force the company to raise capital at unfavorable terms if market conditions deteriorate

At $11.58 per share, Walgreens trades at 7.9x forward P/E. To fully understand why you should be careful with WBA, check out our full research report (it’s free).

Stocks We Like More

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