Bank of America details 7 reasons to buy discount store stocks as earnings reports loom

• After banks' and tech giants' earnings largely impressed Wall Street, discount stores are set to post similarly positive results, according to Bank of America.
• The firm's analysts expect the sector's second-quarter figures to hold strong thanks to rising food sales and improvement in general merchandise revenue.
• Walmart, Target, and Dollar Tree are the analysts' top picks thanks to momentum in higher-profit categories and successful online operations.
• Here are the seven reasons the bank expects discount stores to outperform in their quarterly reports.
• Visit the Business Insider homepage for more stories.

Discount stores' earnings reports could reveal the next bright spot in the coronavirus-rattled economy, according to Bank of America.

Analysts led by Robert Ohmes hold "buy" ratings on popular retailers including Costco, Target, Walmart, and Albertsons heading into their second-quarter reports. The sector is one of the few relatively insulated by the pandemic, as early pivots to e-commerce units pay off and consumers boost spending at lower price points.

The firm sees Target, Dollar Tree, and Walmart as the best names heading into earnings. Target "should benefit from a broadening of momentum" into more profitable categories including home items and clothing, the analysts wrote. A clearing of excess inventory and rebounding demand can boost Dollar Tree higher, and Walmart's second quarter was likely bolstered by strong grocery and general merchandise sales, they added.

Still, the team sees the entire discount store sector as a prime pick as the pandemic rages on. Here are the seven reasons for Bank of America's bullish outlook.

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Food strength

Food sales held up well throughout the second quarter, the bank said, even as some bars and restaurants reopened. The trend supports potential same-store sales upside for the sector, particularly those focused on food items.

Broadened revenue streams

Bank of America expects momentum in general merchandise sales to spill over into other categories throughout the three-month period. Home, apparel, and solitary leisure items are set to benefit from robust sales growth, the team wrote.

Spending in the categories jumped across all income categories, they added. Yet discount stores will likely benefit most, as the return to growth was primarily driven by lower-income Americans.

E-commerce swing

Target and Walmart are both fairly late entrants into the online retail sector, but their pivots came at just the right time. Online grocery sales growth likely continued through the summer even as some activity shifted to physical locations for non-food items, the analysts wrote. The bank sees a 100% upside risk for both aforementioned companies from improving general merchandise and grocery trends.

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Out with promos, in with profits

A drop in industry promotions from the first quarter likely boosted food inflation and overall profitability, Bank of America said. An increase in discretionary spending can further pad discount stores' margins, the firm added, with Walmart, Dollar Tree, Target, and Dollar General set to benefit the most.

Swelling market share

Appealing prices across a range of items could've even boosted the sector's market share over rivals such as Amazon, according to the analysts. Consumers are increasingly favoring one-stop shops instead of spreading their spending over several locations. This trend plays directly into the hands of warehouse clubs, dollar stores, and large discount outlets, Bank of America said.

Shrinking expenses

Though some costs, including sanitation and protective items, will persist throughout the pandemic, most expenses related to the coronavirus likely landed in the first quarter, the analysts wrote. The moderation of COVID-related costs should help firms' second-quarter profit readings.

Pulling it forward

Investors will pay close attention to firms' forward guidance for signs of which company can best perform through a prolonged shutdown. Any signs of large second-quarter cash flow "should enhance 2021" earnings outlooks, the team said, as it could help retailers pay off debts and pull investments forward.

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