Is This Troubled Department Store a Good Investment?

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

J.C. Penney (NYSE: JCP) has been in a period of decline over the past several years, as department stores in general have been forced to contend with competition from Internet retailers such as Amazon as well as discount retailers including Target and Wal-Mart. Its stock price is down 46% in the last year. Even billionaire Bill Ackman’s involvement as an activist, helping name Ron Johnson to be J.C. Penney’s CEO, has failed to turn around the company and in fact, conditions for the company have continued to worsen.

Taking a closer look at the company

The first quarter of J.C. Penney’s fiscal year ended in early May 2013. Revenue fell 16% versus a year earlier, essentially matching the decline in comparable store sales -- a remarkably steep decline for a department store. Operating and net losses were more than double what they had been in the prior year period, and in this quarter alone, the company lost $1.58 per share. Cash flow from operations was also negative, forcing J.C. Penney to draw on its short term borrowing capabilities.

Wall Street analysts expect the company to lose $3.17 per share in the current fiscal year (note that this implies a significant improvement for the rest of the year, as J.C. Penney is effectively halfway to that point after just one quarter). There’s then quite a spread of forecasts for the forward fiscal year, which ends in January 2015. While some on the sell-side have the company breaking into the black, the average figure is a loss of $1.29 per share in that year as well. 25% of J.C. Penney’s float is held short as many market players consider it overvalued at the current price, and the factors driving the company’s weak performance certainly do not seem to be moderating.

Insider Monkey tracks quarterly 13F filings from hundreds of hedge funds and other notable investors as part of our work researching investment strategies (we have discovered, for example, that the most popular small cap stocks among hedge funds generate an average excess return of 18 percentage points per year). We can also use this database to track interest in individual stocks; for example, Tiger Global Management initiated a position of 5.4 million shares in J.C. Penney during the first quarter of 2013 (see Tiger Global's stock picks). Of course, the retailer is one of Pershing Square’s significant holdings as well (find Ackman's favorite stocks).

Peer department stores

One peer for J.C. Penney is Kohl’s (NYSE: KSS). Kohl’s also struggled during its fiscal Q1, though results were at least somewhat better: sales were down “only” 1% compared to the same period in 2012 with a 5% decrease in net income. The department store is valued at trailing and forward earnings multiples of 13 and 11, respectively, so if it could manage to hold its profits steady, then it could be a prospective value stock. However, at least for now, financials are weak enough that investors should be wary of depending on Kohl’s to maintain its current business and should probably shy away from buying.

Macy’s (NYSE: M) has been handling current industry conditions a bit better than either of these two players, at least for now. Comparable store sales and revenue were actually up, although at only a 4% rate, in its most recent quarter compared to the same period in the previous fiscal year. Still, because Macy’s was able to increase its operating margin and reduce its interest expenses over the intervening year, the result was a double-digit percentage increase in earnings. Future earnings growth at that rate, based primarily on higher margins is not sustainable, but even small increases in net income would represent an improvement compared to industry peers.

In addition, Macy’s is valued at only a small premium to Kohl’s in terms of trailing earnings with a P/E multiple of 14. Analysts expect at least modest growth on the bottom line over the next several years, and as a result, the forward earnings multiple is 11 with a five-year PEG ratio below 1. While investors shouldn’t be too confident that Macy’s will continue to grow its same-store sales in what is such a challenging environment for its peers, its relative prosperity and only slightly higher valuation than Kohl’s does make it at least a potential value play.

Conclusion

As a result, Macy’s appears to be a somewhat more interesting target than Kohl’s and certainly a less risky pick than J.C. Penney. While the latter could certainly improve in the long term, analysts are generally expecting it to be unprofitable next year, and considering how poorly its business has been doing, it does not seem worth buying.

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This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool has no position in any of the stocks mentioned. 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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