Weighing Three Retailer Stocks

aakanksha is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Clothing, gadgets, and other consumer items aren't the only things on sale this January. Many of the biggest-name retailers at your local mall have seen their own share prices dumped on the clearance rack as well. But investors be warned: Many stocks are on sale for good reason—and investors need to show some early-year resolve.

Electronics giant Best Buy’s (NYSE: BBY) stock has halved in the past year, while department-store chain J.C. Penney (NYSE: JPC) has fallen by a third. Books giant Barnes & Noble (NYSE: BKS) is down a fifth since the start of November. Analysts blame worries about the economy, competition from online rivals such as Amazon.com and, in some cases, management decisions.

Meanwhile, the Standard & Poor's 500-stock index rose 13% in 2012, and the S&P Retail index by 19%.Fears of falling off the cliff are gone as the bull market reaches new heights. In a classic example of how fast investors' mood can turn from intense fear to enthusiasm, the Standard & Poor's 500 rocketed 4.6% to 1466.47. That number is significant because it pushes the broad market index to its highest level since the end of 2007, just before the financial crisis sent stocks into a historic tailspin.

Retail is the rare industry where the average investor can often play on level terms with the pros. The companies succeed based on how well they serve ordinary consumers. But investors need to distinguish between sound companies that are going through a bad patch and the ones in terminal decline.

A look at the three stocks shows the risks and rewards:

J.C. Penney suffered a $123 million net loss in the third quarter. Same-store sales plunged 26%, while online sales dropped 37%. The company's debt has been downgraded to "junk" status by rating agencies. Yet the underlying picture is better, argue some analysts. The company is in the early stages of an attempted turnaround under new Chief Executive Ron Johnson, who took over in 2011. He came from Apple where he had built up the company's retail operations. Mr. Johnson is moving Penney upscale. He has cut the retailer's reliance on sales and is rolling out a new store format with fancier brands.

With $525 million on cash at the end of last quarter, Penney isn't facing an immediate liquidity crunch. Current assets, at $4.6 billion, handily exceeded current liabilities of $2.8 billion. The stock, at $20.62, is valued at about 30% of annual per-share revenue. That is half the rating of rivals Macy and Target. Even though there are a lot of if’s and risks, the stock could easily see the high 20’s again.

Barnes & Noble also is a chancy play. The bookstore giant is losing market share to Amazon's online sales and to e-book readers such as Amazon's Kindle. It has disclosed disappointing holiday sales, including slowing sales of its own e-books and Nook e-book readers and tablets. A decade ago Apple's iTunes wiped out the record stores in short order. Barnes & Noble investors must fear a similar outcome for bookstores. New Chief Executive William Lynch recently admitted he doesn't even read many printed books any more.

Yet there is one bullish scenario. Barnes & Noble could be a profitable investment if the company were to sell its stake in Nook Media and focus instead on harvesting the remaining cash flow from its bookstores for dividends, some analysts say. That would be a sharp change from the current strategy of funneling all bookstore profits into the loss-making Nook venture. The company's nearly 1,400 bookstores—half of them on college campuses—could produce more than $1 billion in pretax operating cash flow over the next five years if they were simply managed as a stand-alone business. That would be about $17 per Barnes & Noble share. The whole company trades at just $13.35 now.

Meanwhile, the Nook Media business has attracted major investments from Microsoft and, more recently, publishing giant Pearson that both valued the loss-making venture at $1.8 billion. That values Barnes & Noble's remaining stake in Nook Media at $1.4 billion or $23 a share. But while there is potential upside, investors would see it only if management takes the right steps.

Best Buy looks even riskier, but might just offer a quick profit. The stock has plunged to $12.11 from a peak of $27 early last year. Not long ago the company dominated sales of electronics. Now analysts say consumers visit the store to look at new tablets, phones and other gadgets, only to buy them more cheaply online.

"Amazon and other Internet retailers have done away with the electronic brick-and-mortar sales model," Richard Schulze, Best Buy's founder and former chief executive, is considering a bid to take the company private. Last summer, when Best Buy's stock was much higher, Mr. Schulze talked about offering up to $26 a share. There is no guarantee he will make an offer next month, nor that he would match that price. The stock's low price shows investors are skeptical. Yet if Mr. Schulze were to table a bid, investors might make a quick return. Just like in shopping, bargains are in the eyes of the beholder in stock picking also! 

Aakanksha19 has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Apple. The Motley Fool owns shares of Amazon.com, Apple, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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