Two Top Picks Amongst US Retailers

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When we talk about departmental stores, we naturally tend to think about their relatively stable topline. But that’s not the case with all retail stores and J.C. Penney (NYSE: JCP) is a classic example of that. It’s encoded into human nature to run after value for money, but J.C. Penney has not been able to deliver deep discounts like retail mammoth, Wal-Mart (NYSE: WMT). As a result, its same-store sales plunged and rising expenses ate into its earnings. But J.C. Penney has not been sitting idle.

A Change in Strategy

The department store recently adopted the strategy of comparative pricing. Each product in its store will carry a “suggested price,” which would make its products look discounted without actually giving discounts. Although, this might temporarily boost its sales, history has shown that such strategies don’t work without actual discounts. As a matter of fact, Indian brands like Cantabil and Pantaloons, have around 60%-80% discounts throughout the year. Most consumers no longer believe their discount offers and I think J.C. Penney could be heading down the same road.

J.C. Penney also announced that it would be opening “Martha Stewart” shops in its existing stores, as it owns 16.6% stake in Martha Stewart Living. But Macy’s (NYSE: M) sued J.C. Penney soon after the announcement, stating that it had exclusive rights to sell Martha Stewart merchandise until 2018. Both the companies are battling it out in court, and from the hearings it has come to light that J.C. Penney doesn’t intend to use the brand name “Martha Stewart,” but instead would work with her to develop a new brand. The contract with Macy’s however does not prohibit Martha Stewart from working as a designer with other brands. But the court might see a “conflict of interest” and might rule in favor of Macy’s if their products do not differ.

Gone Too Far?

As a desperate measure, its management laid off an undisclosed number of store personnel at its 1,100 locations. Furthermore, it dumped its commission based pay scale and switched to hourly pays. Over the shorter term, these moves could be profitable for the company, but this would definitely lead to de-motivated employees and understaffed stores.

J.C. Penney also began operations in India, and opened up an online retail store. But strangely, it has not yet become involved in mass advertising. India has a massive retail market, with huge growth opportunities for organized retail. Without mass advertising and a proper discount structure, I don’t think the company will be able to make a mark. Seeing this opportunity, Wal-Mart and Bharti group together are already operating in India.

Metric Comparison

J.C. Penney shares it retail market share with Wal-Mart, Macy’s and Sears Holdings (NASDAQ: SHLD).

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p> P/E</p> </td> <td> <p>Debt/Equity</p> </td> <td> <p>Gross Margin</p> </td> </tr> <tr> <td> <p>JC Penney</p> </td> <td> <p>-9.05x</p> </td> <td> <p>85%</p> </td> <td> <p>32.9%</p> </td> </tr> <tr> <td> <p>Wal-Mart</p> </td> <td> <p>12.25x</p> </td> <td> <p>125%</p> </td> <td> <p>40.37%</p> </td> </tr> <tr> <td> <p>Macy’s</p> </td> <td> <p>14.09x</p> </td> <td> <p>83%</p> </td> <td> <p>78%</p> </td> </tr> <tr> <td> <p>Sears Holdings</p> </td> <td> <p>-10.48x</p> </td> <td> <p>104%</p> </td> <td> <p>26.04%</p> </td> </tr> </tbody> </table>

From the mentioned peers, J.C. Penney and Sears Holdings have been bleeding pretty badly. This might interest contrarians, but the risk averse should certainly stay distant. Wal-Mart and Macy’s appear to be attractive, with high gross margins and seemingly undervalued stock prices. Analysts estimate their annual EPS growth to average around 9.26% (Wal-Mart) and 11.62% (Macy’s).

Conclusion

In my honest opinion, J.C. Penney has to do more than just comparative pricing and cost cuts. It needs positive catalysts to grow. That said, the fight for “Martha Stewart” is on, and any positive court ruling could power up its stock. In my opinion, risk averse investors should instead look to invest in Macy’s and Wal-Mart for their growth prospects.


PiyushArora 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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