Macy's Will Outperform These 2 Retail Competitors
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As retailers hike up marketing spending going into into the critical holiday season, investors need to carefully track corporate fundamentals in advance. While some department stores are in "turnaround mode," this is no reason to give them the benefit of the doubt that all will be good to go by Black Friday. I recommend not taking on the risk of backing turnaround retailers when there are perfectly strong retailers that are gaining share despite challenging macro conditions. Below, I consider the market environment and attractive investment opportunities.
Consistent Excellence For Macy's (NYSE: M)
While the stock has gone nowhere over the last 3 months, Macy's shareholders have still fared better than the 3.5% decline in the S&P 500 over the same period, and over the year to date with a return of 20.9%. The reasons for this outperformance are simple; first, the company has done terrific in online business, which bodes well for a secular transition away from brick-and-mortar sales. Second, earnings have consistently been above expectations over the last 5 quarters. In addition, the multiples are highly compelling.
Macy's trades at a respective 12.2x and 10.2x past and forward earnings. By contrast, the historical 5-year average P/E multiple is 13.2x. Annual free cash flow of $1.8 billion is quite strong (a 11.5% yield), and it has been on an upward trajectory. Analysts forecast 10.8% annual EPS growth over the next 5 years. Assuming Macy's meets expectations, 2016 EPS will come out to $5.20. At a multiple of 15x, this translates to a future stock value of $78. Discounting backwards by 10% yields a present value of $48.43, which is at nearly a 30% premium to the prevailing price. I thus strongly encourage an investment.
Stocks are ultimately valued based on the future earnings streams. Fortunately, Macy's looks strong from this perspective. As J.C. Penney (NYSE: JCP) continues to decline from a poor restructuring, Macy's has been gaining market share. Both retailers actively compete in shopping malls, but the primary reason behind Macy's out-performance over J.C. Penney has to do with double-digit online sales growth. By contrast, the latter has seen a 26% drop in sales relative to the same quarter last year. In the process, J.C. Penney has lost slightly more than half of its value over the last 12 months.
Kohl's (NYSE: KSS): The Good & The Bad
Like J.C. Penney, Kohl's has also struggled over the last 12 months--losing nearly 10% of its value and under-performing the S&P 500 by nearly 1,700 basis points. But at least free cash flow trends have been decent at around $930 million, or a 7.8% yield against the market capitalization. And it is quite cheap, at a respective 11.8x and 10.1x past and forward earnings, with a 2.5% dividend yield. Performance has also been consistently better than expectations in all of the last 5 quarters, and the average beat was 3.2%.
During the recent quarter, same-store sales were still up 1.1%, which reflected greater transactions, volume, and revenue per square foot. e-Commerce sales were also up 50% over the same quarter last year, though gross margin fell 44 bps. Footwear and the South Central were particularly strong in the recent quarter.
And perhaps most importantly, a majority of sales came from exclusive / private Kohl's brands, which suggests a sustainable economic moat. New lines, such as Jennifer Lopez, Princess Vera Wang, Chaps, FILA SPORT, and Marc Anthony have been huge hits. The promotion involved in getting these brand launches out into the market help explain away much of the margin woes. Note that higher market leverage is likely to continue into the fourth quarter.
Perhaps the best indication that the business is doing well is that new stores are being opened, with 12 in just 3Q 2012. All but one of the new stores, however, are small and will help test out a strategy of increasing sales per square foot. With several dozen stores remodeled, the company's growth story bodes well into the holiday season.
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