Retail Sector Recovery: Navigating Volatility Amid May's Sales Decline

The U.S. retail sector faced a significant test in May 2025, with total sales declining by 0.9%—a sharper drop than anticipated—amid rising tariffs, geopolitical tensions, and lingering inflation. While the headline figure signals broader economic caution, a closer look reveals pockets of resilience in specific sub-sectors. For investors, this downturn presents a critical opportunity to identify undervalued stocks in sectors poised to outperform as consumer behavior stabilizes.

Ask Aime: Are there any undervalued stocks in the retail sector after the 0.9% decline in sales in May 2025?

The Catalyst: May's Decline and Its Underlying Drivers

The 0.9% sales decline followed a 0.1% drop in April, marking the weakest back-to-back performance since early 2023. Excluding autos, sales fell 0.3%, underscoring a broad-based slowdown. However, the control group—a subset of retail data used for GDP calculations—rose 0.4%, hinting at underlying strength in non-volatile categories. Key drivers of the decline included:
- Falling discretionary spending: Apparel, furniture, and building materials saw steep declines (e.g., building materials down 7.31% YoY).
- Energy price volatility: Gas stations and automotive-related sectors suffered.
- Post-tariff demand fatigue: Earlier “pull-forward” purchases in tech and discretionary items faded as tariffs took hold.

Yet, certain sub-sectors thrived, insulated by their essential nature or price-conscious appeal.

Resilient Sub-Sectors: Where to Focus Now

1. Essentials Retailers: A Foundation of Stability
Grocery and beverage retailers posted a 4.53% annual sales increase, driven by steady demand for food and beverages despite flat unit sales (revenue growth was price-driven). Health and personal care sales rose 3.85% YoY, reflecting inelastic demand for medications and hygiene products.

Investment Takeaway:
- Walmart (WMT) and Kroger (KR) remain defensive plays, benefiting from their scale, diversified product mix, and exposure to both essentials and e-commerce.
- CVS Health (CVS) and Walgreens (WBA) offer exposure to health care's steady demand, though operational challenges in drugstores warrant caution.

2. Discount and Value-Oriented Retailers: Outperforming in a Cost-Conscious Era
General merchandise stores grew 4.63% YoY, with discount retailers like Dollar General (DG) and Dollar Tree (DLTR) likely fueling this trend. While discretionary spending in apparel and beauty pulled back, discount stores capitalized on consumers prioritizing affordability.

Investment Takeaway:
Discount retailers with strong balance sheets and low-price strategies are well-positioned to capture market share. DG and TJX Companies (TJX) (off-price retailers) could benefit from shoppers seeking value without sacrificing quality.

3. E-commerce and Digital Products: The Growth Engine
Digital products—a category including tech accessories and streaming services—surged 28.04% annually, outpacing even pre-pandemic e-commerce trends. Amazon (AMZN), Best Buy (BBY), and niche players like Peloton (PTON) (fitness tech) are beneficiaries of this shift.

Investment Takeaway:
While Amazon's dominance is undeniable, smaller players in niche e-commerce segments (e.g., Wayfair (W) for home goods) may offer higher growth potential if they can scale efficiently.

Navigating Volatility: Short-Term Entry Points and Risks

Entry Points:
- Post-recession recovery patterns: Historically, retail sectors like groceries and health care rebound faster than discretionary categories. For example, during the 2020 pandemic downturn, essentials retailers outperformed by 15–20% in the following 12 months.
- Valuation discounts: Discount retailers like DG trade at 12x forward earnings versus their five-year average of 15x, offering a margin of safety.

Risks:
- Inflation persistence: Higher input costs could squeeze margins for grocers and discount retailers.
- Consumer sentiment: A further decline in confidence could dampen even essentials sales if unemployment rises.

Conclusion: Selective Opportunities in a Challenging Landscape

May's decline is not a death knell for retail but a reminder of its cyclical nature. Investors should prioritize essentials-driven businesses, discount retailers with pricing power, and e-commerce leaders with defensible market positions. Avoid overexposure to discretionary sectors like furniture or building materials until economic clarity emerges.

For now, the resilience of sectors like grocery, health care, and tech-driven e-commerce suggests that WMT, DG, and AMZN—coupled with a watch on emerging players in digital products—are the safest bets to navigate volatility and capitalize on recovery trends.

JR Research advises investors to conduct due diligence and consider their risk tolerance before making any investment decisions.