Buy Macy's Over J.C. Penney
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
After J.C. Penney's (NYSE: JCP) recent quarterly earnings miss, many pundits have labeled Penney CEO Ron Johnson and his turn around plan a failure. However, with the stock over 40% off its high, the turn around anything but over, and a pair of successful value investors (Bill Ackman and Whitney Tilson) taking very public positions in the stock, I thought the name became worthy of a closer look.
The negative sentiment came to a head on May 15 when J.C. Penney announced an abysmal first quarter (same store sales fell 18.9%, traffic fell 10%, shopper conversion fell 5%, average spend per visit fell 5%). These shockingly bad numbers cast doubt on Johnson's turn around plan (they claimed the new pricing strategy is confusing and is driving away customers conditioned to coupon shopping) and even led some to say he's running the 100 year old company into the ground.
While I do not believe Penney's turn around will be completely seamless going forward, I disagree with the notion that Johnson will bankrupt the company. While the pricing strategy may confuse some customers, I believe shoppers will adapt to the pricing strategy as they spend more time in the store. What will drive shoppers to the stores if not sales? Products. Remember that Johnson's strategy is product-driven. The pricing changes were made to attract brands that did not want to play the mark-up/deep-discount game. With the best advertising campaign I've seen from the store and a number of strong brands interested in “shops” within the store, I believe Penney will ultimately have no problem attracting customers.
However, believing Ron Johnson will ultimately succeed at J.C. Penney does not mean the company's stock is currently a good investment. Comparing J.C. Penney to Macy's , we see that Penney is overpriced. Macy's forecasted full year GAAP earnings of $3.25-$3.30, giving it a P/E ratio around 11.5. J.C. Penney is harder to forecast since management did got give GAAP earnings guidance. The company did say they expected $2.16 in non-GAAP earnings. Since their previous full year 2012 guidance was for $2.16 in non-GAAP earnings and $1.59 in GAAP earnings, we can assume that $1.59 is the top of GAAP earnings for this year. Using $1.59 as an estimate for this year's earnings, we find that J.C. Penney is trading at 15.6 times earnings, a premium to Macy's
Does J.C. Penney deserve to trade at a premium to Macy's? If you believe (as Johnson does) that J.C. Penney will become America's favorite store, with great products and a visionary CEO, then perhaps J.C. Penney deserves the 16 multiple. However, J.C. Penney is not that company yet. At the moment, the company is a third of the way through a complete overhaul, and the stock's multiple should reflect the uncertainty that comes with that change. One could knock a couple points off the optimistic multiple and come to a valuation of $22.26 (14 times $1.59). However, with a solid business like Macy's trading at 11.5, I see many investors passing on J.C. Penney in favor of Macy's until the multiples converge. In this case, Penney's stock would trade at $18.29 (11.5 times $1.59). If Penney's transition falters and investors further dismiss Johnson's vision, shares could trade at a discounted multiple to Macy's, perhaps being valued as low as $15.10 a share (9.5 times $1.59).
All of this is, of course, speculation; however, based on the analysis above, I prefer Macy's over J.C. Penney and would not look to swap into J.C. Penney until the two trade at the same multiple or the transition is complete.
dtlly has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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.If you have questions about this post or the Fool’s blog network, click here for information.