The Prince and the Pauper: Apparel for Everyone

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

From low to high-end retailers, the apparel industry offers plenty of growth opportunities for those wise enough to seize them. In this article I will look into three companies within this segment that target very different demographics: J.C. Penney (NYSE: JCP) for the lower-end markets, Macy’s (NYSE: M) for the middle-end, and Saks (NYSE: SKS) for those wealthy enough to afford it.  Through a brief analysis, I will try to elucidate which of these firms stands as the best long-term investment opportunity.

Pennies for J.C.

J.C. Penney is a retailer that offers its products (mainly apparel, accessories, and personal services) through its recognized department stores, catalogs and websites. Despite being one of the leading retailers in the U.S. and Puerto Rico, the company has been facing rough times lately. This has been reflected in its margins and returns, all negative and well below industry averages. Same can be said about its last reported results, which once again failed to meet consensus expectations. So, even trading at 0.3 times its sales and 1.4 times its book value - substantially below industry average valuations - I’d recommend holding on this stock for now.

Once strongly differentiated for its prices, J.C. Penney is now losing market share to other higher-end specialty retailers like Macy’s, which now offer low prices and high value products, and to other sector behemoths like Wal-Mart and Target that appeal to more price-sensitive audiences. The stiff competition and limitations imposed by the recession and U.S. fiscal policies on the middle-class have and will most likely continue to impact on the firm’s top and bottom line results. Moreover, this clientele loss seem permanent, as sales continue to decrease.

Poor recent financial results and weak growth and profitability figures discourage me from investing in this firm at the moment. However, I’d advocate keeping a close eye on it as its revamping plans, supported by strong liquidity and cash flows, could start paying off by 2014.

Macy's day parade

Macy’s is one of the most famous brand names in the retail segment. Since I was a little kid, I knew that Macy’s combined good prices with a quality product offering. Over the last couple of decades, the firm and its stock have outperformed its peers, including J.C. Penney and Saks. So, currently trading at under 14.6 times its earnings, about a 16% discount to the industry average, is this stock a buy? I’d say it is, especially for the long-term.

Going forward, the company will rely on its omni-channel retail strategy, which makes its merchandise available not only at its stores, but also at its websites and mobile/tablet platforms. Furthermore, the “My Macy’s” initiative will help better meet its customers’ demands. All of this will help Macy´s expand its reach (and customer base) and benefit from the increasing use of smartphones and other portable devices. “Price optimization, inventory management, merchandise planning, and private label offering” are the other main growth catalysts for the years to come (Zacks).

With industry leading margins and growth records and above average returns, the company has amassed considerable amounts of cash. Management has been using this cash flow to return value to shareholders through dividends (yielding about 2%) and share repurchases, in addition to repaying debt and strategically investing in new stores.

If you are willing to spend a few bucks…

Saks is a long way from J.C. Penney. As a luxury retailer, it aims at high-end customers looking for quality or brand-names more than for competitive pricing. Just like Macy’s, Saks relies on a developed onmi-channel retail system which increases its exposure to various demographics and levels of customer spending.

However, trading at 47 times its earnings, about 3 times the industry average, while offering margins and returns quite under its peers’ means this stock looks like a hold case at the time. Just like its products, Saks´ stocks seem a little overvalued; nevertheless, those willing and able to pay a premium price will receive a premium product: The company is expected to deliver above average upside over the years to come on the back of industry outperforming EPS growth rates.

Although macro-economic headwinds, a late entry to omni-channel retailing, and limited expansion opportunities (beyond improving comps) put a cap on Saks’ growth prospects, an operational and strategic revamping plan should prove beneficial going forward.  Private labels and online and mobile sales platforms are expected to drive growth over the next few years. Holding one of the strongest brand-names in the industry, this is a stock to keep on your radar.

Bottom line

Although all three firms are industry leaders and hold world-recognized brand names, Macy’s leads the bunch, not only on account of its past results, but also due to its compelling growth prospects and expansion opportunities. Consider buying and holding on to this stock for the long-term; EPS growth is expected around 15% per annum over the next five years.

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