Millions of Americans remain absent from the workforce, and even those with jobs are wrestling with stagnant income growth. That helps explain why retailers have experienced a half decade of subpar sales growth. Yet that bleak recent history may soon be coming to an end.

Wages, job openings and retail spending are inter-locking variables, and for a change, these factors are pointing to brighter days ahead.

Of course it all starts with jobs. As we saw with the most recent employment report, the national unemployment rate stands firmly below 6%, a threshold that seemed almost inconceivable just a few years ago.  
 

Favorable Employment Trends

Source: Bureau of Labor Statistics​

Despite the robust period of job creation, employees still lacked any leverage when it came time to seek wages. Yet that dynamic may be changing. Wages in the private sector grew 2.8% in the first quarter, the best showing since 2008. That may not seem like a big jump, but the trend is encouraging.

Early signs of wage growth may be having an impact on consumers. According to the University of Michigan, consumer sentiment just rose to its highest levels since 2007. The monthly survey of perceived economic conditions rose 8.4% from a year ago to 107.

Connect the dots and the stage appears to be set for a long-awaited renaissance in consumer spending. Yet there’s just one problem. Many major retail stocks, as measured by the SPDR S&P Retail ETF (NYSE: XRT) already appear to anticipate better days ahead.

Simply put, it’s hard to find clear value opportunities among large retail stocks right now. Yet if you are willing to swim downstream to the small caps, much more compelling opportunities emerge. Here are three that are on my radar right now.

Bebe Stores, Inc.  (Nasdaq: BEBE)
This provider of women’s apparel and accessories has always had a reputation for glamorous and bold designs. It has also had a reputation for a weak financial performance. That’s largely due to negative operating leverage as sales have fallen by a third since fiscal (July) 2007 to below $450 million. The retailer has generated negative free cash flow for three straight years, leading the cash balance to steadily fall.

Shares, which traded above $20 a decade ago, now trade for around $3.40. (They took a fresh tumble on Friday when Bebe announced plans to suspend its dividend to preserve cash.) 

But a turn may be at hand. Jim Wiggett was made CEO in December 2014 and is now pushing the company into international markets, which is building a more robust online sales presence. Wiggett was previously successful at the helm of cosmetics retailer Sephora.

The new CEO is also changing the company’s pricing strategy, sharply reducing the number of promotional sales events that tend to bring in little by way of gross profits.

Yet the real test is in the appeal of the merchandise, and by that measure, Bebe is beginning to resonate with customers. Same store sales have been positive for three straight quarters. Adrienne Tennant, who follows the stock at Janney Montgomery, sees 50% upside to her $5 price target, noting that such a target implies a still-modest enterprise value-to-sales ratio of 0.6.

Francesca’s Holdings Corp. (Nasdaq: FRAN)
Investors made a classic mistake with this women’s retailer. They assumed that torrid sales trends in the first few quarters after its initial public offering could be sustained. Going up against robust prior-year comparisons eventually leads to a much slower growth rate. When that happened, most investors fled.

Yet some investors have stuck around, noting that the retailer’s low-inventory, high-turnover approach can lead to solid profit margins. Francesca’s gross margins have averaged around 50% over the past five years, which is one of the highest in the business, reflecting the fact that profit-sapping sales are rarely needed to move stale inventory.

#-ad_banner-#Still, Francesca’s was in need of fresh management to reverse a string of weaker-than-expected sales reports. The hiring of retail industry veteran Michael Barnes in December was widely applauded by investors. He is responsible for strong results at retailers Fossil and Signet Jewelers.

Barnes understands the value of the retailer’s unique merchandising approach: “With lower inventories to start the year, we are in an improved position to chase developing fashion trends and drive more newness and innovation in our assortments,” he told investors in a late-March conference call. 

On the next conference call, slated for early June, Barnes is likely to have much more to share regarding his efforts to restore Francesca’s same store sales trends to a higher place. As it stands, analysts are modeling for flat comps, and double-digit sales gains in fiscal (January) 2016 and 2017, due solely to new store openings. Higher comps would nudge those sales forecasts yet higher.

Destination XL Group, Inc. (Nasdaq: DXLG)
I love to see retailers that have a niche all to themselves. This retailer is the only pure play dedicated to “big and tall” men, stocking business and casual wear in larger sizes. Destination XL has been tweaking its store base format for several years, closing smaller stores (which were branded as “Casual Male”) and replacing them with the new company name and in larger store sizes. An improving employment outlook should provide the impetus for many men to spruce up their wardrobes as they gear up to go on interviews.

Risks To Consider: The industrial end of the U.S. economy has begun to wobble, so renewed consumer confidence may still prove to be ephemeral.

Action To Take –> All of these retailers sport very low price-to-sales multiples, reflective of recent struggles. Yet each of them is led by management teams that are tweaking the business models to boost profits. A firming U.S. consumer economy would really help their efforts to show through on the bottom line.

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