Are These Department-Store Giants As Similar As They Appear?

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

With two of the biggest U.S. mall retailers set to report earnings a day apart next week, I figured I would do a little comparison.  When the average American hears the names Macy’s (NYSE: M) and J.C. Penney (NYSE: JCP), the first thing they may think of is just how similar these two companies are.  However, while the two companies’ stores may sell similar products and even look similar, as investments these companies are as different as night and day.

Profiles

Let’s start with a little bit about the two companies.  Macy’s operates about 850 department stores under both their own name and the Bloomingdale’s name, offering a range of merchandise including apparel, cosmetics, home furnishings, and other products.  The company also operates a substantial online business through both macys.com and bloomingdales.com.  Last year, Macy’s did over $26.4 billion in sales, and had earnings of $2.92 per share.

J.C. Penney seems very similar on the surface, and is actually the leading mall-based department store operator based on the number of stores with over 1,100 locations in 49 states and Puerto Rico, and they offer a very similar assortment of products as Macy’s.  Unlike Macy’s, sales have been on a decline, with the steepest losses in sales expected for the current year. 

Macy’s earned $1.28 per share for fiscal year 2012; however they are expected to post losses for the next two years.  It is fair to say at this point that Macy’s seems to be in much better shape, financially.

Performance

Although Macy’s sales experienced a small dip after the recent recession, the company has grown sales nicely over the past three years, and earnings have grown along with it.  As a result, shares have climbed from their 2009 low of $5.07 to the current level of just under $40. 

 

In addition, Macy’s has a nice record of creating shareholder value through both dividends and buybacks.  The shares yield 2% annually, and the total number of outstanding shares has dropped from 427.3 million to 395.3 million just in the past two years, a reduction of 7.5%. 

As you can see from the chart above, the trend is the exact opposite for J.C. Penney’s.  Their shareholders have taken a beating, watching their shares that were worth up to $87.18 at one point reduced to under $20. 

So why the sales plunge from J.C. Penney’s?  The company is currently in the middle of a restructuring plan to adapt to changing business dynamics, and as a result, there are some expenses and losses that come with it.  The company discontinued its famous “big book” catalogs in 2011, and they plan to update all 1,100 of their stores to modernize their look and attract new customers. 

As a result of the restructuring, the company expects to return to profitability in FY 2014 and produce a 13% operating margin by FY 2016.

Valuation

The point of that J.C. Penney rant is to emphasize that these are truly two different kinds of investments.  J.C. Penney works purely as a speculative play right now, and with the higher risk comes higher potential rewards.

For example, if the company achieves a 13% operating margin as planned, and builds sales back up to around $15 billion, which I think is conservative; this would translate to $8.90 per share in earnings.  So, if everything goes according to plan, J.C. Penney’s is trading at just 2.2 times 2016’s earnings.  However, that is a big “if.”  This one can go sour in a hurry if the company’s efforts don’t produce the desired effect.

Macy’s, on the other hand, is a much more stable investment, and I think it is very attractively valued right now, at just 12.4 times earnings with 14.8% annual forward growth projected.  As such, a comparison with J.C. Penney is not very useful.  I would be more inclined to compare Macy’s with a department store chain in similar financial shape, such as Kohl’s (NYSE: KSS).

Kohl’s actually trades at a lower valuation of just 11.2 times current-year earnings; however their 3-year average annual growth estimates are just 6.8%.  This growth is in line with the valuation, however is not nearly as attractive as Macy’s.

The Bottom Line

Which department-store chain you should ultimately decide to put your money in is all about the risk tolerance you have.  There are high-risk, medium-risk, and low-risk choices out there.

Companies that may or may not make money, like J.C. Penney’s, are high-risk.  While they have the most potential to lose money, they can also pan out wonderfully if things go well.  If the company actually meets their ambitious goals by 2016, this could be a $100 stock.

Medium-risk would be companies like Kohl’s or Macy’s, of whom I think Macy’s is very attractive right now.  For those investors with a low risk tolerance, specialty retailers are probably not for you, and the best bet is a giant retailer who sells almost everything, like Target (NYSE: TGT), which also reports earnings next week.  As a less-risky play, Target trades at a slightly higher 13.7 P/E multiple with projected forward growth of 10.8%, and in my opinion, is one of the safest ways to get exposure to the up-trending retail sector.


KWMatt82 has no position in any stocks mentioned. 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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