A Wall Street expert breaks down why 3 smaller retailers are poised for gains amid a down economy — and says they're the best stock-market alternatives to behemoths like Costco and Target

  • Many small caps have struggled amid the economic shutdown.
  • Royce Investment Partners' Jay Kaplan identified three small-cap retail stocks that he says are best-positioned for an ongoing poor economic environment.
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Since the lows of the bear market in March, retail behemoths with strong e-commerce infrastructure have stolen the headlines as the firms best-positioned for a stay-at-home environment.

But some smaller retailers, meanwhile, have done well too — in particular, stocks that have benefited from tightening consumer credit amid a poor economy, according to Jay Kaplan, a portfolio manager at Royce Investment Partners. They include retailers that cater to people who cannot easily access lines of credit because of lower scores or financial hardship.

In a recent interview with Business Insider, Kaplan laid out how still high unemployment rates and the decrease in consumer lending from banks in the US have set some small-cap names up for gains.

Specifically, Kaplan pointed to three smaller retailers he said were poised to continue their upward path as the economy remains relatively downtrodden and lies vulnerable to the coronavirus. 

3 retailers set for gains in a stalled economy

Kaplan first identified two rent-to-own businesses that are well-positioned amid a tight credit environment — and which can act for investors as alternatives to big retailers like Walmart, Amazon, Target, and Costco.

One is Rent-A-Center (RCII), a rent-to-own furniture and appliance retailer whose target market is people with little or no access to credit.

Kaplan is also bullish on the company's recent managerial shift.

"They had some issues a few years back — they had an aborted takeover a few years back. The balance sheet was terrible," he said. "They brought back a management team they had before they got into trouble, and the CEO now has straightened it out. He's paid down most of the debt, they've cut a lot of costs, and now they're in really good shape."

Second, Kaplan highlighted Rent-A-Center's competitor Aaron's (AAN) for how they plan to structure their business moving forward.

"They're going to split their company in two — there's going to be one company that's the traditional brick-and-mortar rent-to-own business, and then there's going to be a separate company that's this third-party rent-to-own in other people's stores business," he said. "That's going to happen sometime by the end of this year, and the market will like that a lot."

He also pointed to Aaron's stronger-than-expected prereleased third-quarter earnings report, in which it reported expected revenue of $1 billion to $1.02 billion, up from a previously expected $950 billion to $975 billion.

Finally, Kaplan recommended Shoe Carnival (SCVL). Though he said it had been hurt by lower back-to-school demand, Kaplan added that it would benefit from competitors like Payless going out of business.

He also said it has enjoyed success in e-commerce sales this year thanks to years of building its online infrastructure. 

"They're a terrific footwear retailer who did an absolutely fabulous job doing business with e-commerce during the pandemic — their e-commerce sales were through the roof," he said. "They've spent a lot of time and a lot of years and a lot of money getting their act together and getting their system together, and it's paid off for them."

Further, Kaplan said Shoe Carnival's locations helped its bottom line amid the pandemic.

"They are mostly not coastal," he said. "So their stores kind of closed late and reopened early. They didn't furlough people, so they were able to open their stores right away."

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