I regularly like to call Wesfarmers Ltd (ASX: WES) one of the best investments on the ASX. It's not surprising to me that the Wesfarmers share price has risen 71% over the past five years due to the strength of the ASX stock's underlying retail businesses of Bunnings and Kmart.

However, when a stock rises a lot, it can become a bigger part of someone's portfolio. That can be a good thing, but it would also be understandable for someone to want a bit more diversification if the portfolio is becoming too focused on one business.

The retail sector could still be an appealing place to look for opportunities for a medium-term investment because when interest rates start coming down, it could lead to an increase in retail spending by Aussie households.

So, below are two of my favourite ASX retail stocks.

Universal Store Holdings Ltd (ASX: UNI)

This company says it owns a portfolio of premium youth fashion brands which have a carefully curated selection of on-trend apparel products to target 16 to 35-year-old fashion-focused customers. It has 102 physical stores across Australia.

Its businesses include Universal Store, CTC (trading as THRILLS and Worship) and Perfect Stranger.

The ASX retail stock has delivered an extraordinary performance considering the difficult trading environment amid high interest rates and elevated inflation.

In FY24, the company reported sales growth of 9.7% to $288.5 million, underlying profit (EBIT) growth of 16.6% to $47.1 million and statutory net profit growth of 45% to $34.3 million.

I thought this result was impressive in a number of ways, including the operating leverage the company demonstrated, where its margins increased, enabling profit to rise much faster than sales.

The trading update for FY25 was also very promising. Universal Store sales were up 15.3%, with like-for-like (LFL) sales growth of 12.5%, while Perfect Stranger sales were up 89.9%, with LFL growth of 24.2%. I think this level of growth bodes well for the future because its products are clearly resonating with customers.

In FY25, it's also working on improving its gross margin, introducing new brands, and reducing its cost of doing business.

Nick Scali Limited (ASX: NCK)

Nick Scali sells furniture through a number of brands, including Nick Scali, Plush, and Fabb Furniture in the UK (following the acquisition).

This ASX retail stock is looking to steadily add to its store networks, particularly with Plush stores in Australia and to grow its UK store network.

Pleasingly, in the first four months of FY25, ANZ written sales orders were 3% higher, with both August and September showing an increase year over year. It's planning to open two Nick Scali stores and between three to five Plush stores in FY25. Freight rates may be higher right now, but I think it will be a shorter-term issue. 

The UK currently has a challenging trading environment, but Nick Scali is already boosting margins there and it expects further improvement as more Nick Scali product is rolled out to stores. It's also looking to reduce costs in its UK business.

Nick Scali said it has moved to the same outsourced delivery model in the UK as ANZ which will "improve the efficiency and scalability of deliveries to customers." In the recent trading update, Nick Scali said regarding its UK operations:

Our strategy is to transform the business to the Nick Scali business model and leverage group capabilities for efficiency and scale before focusing on expansion of the UK showroom network. However, should an attractive new UK showroom location opportunity present, we will consider it.

I think the ASX retail stock has the room to significantly grow profit in the UK and ANZ over the next three to five years.