JC Penney Still a Dead Dog, so Buy This Retailer Instead

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

With the fiscal cliff behind us, investors are starting to focus more on the optimistic side of the economy. This means rising consumer expenditures and less volatility. In this article, I look at two department stores with different momentum; one is thriving, the other is struggling. Has the former peaked? Has the latter hit a low? I consider the future in my assessment of these retailers below.

Reasons to Buy Macy's (NYSE: M)

Macy’s is an American-based chain of department stores. By January 2013, the company had around 800 Macy's and Bloomingdale's stores in the United States. 

The company is expected to produce 2013 EPS of $3.40. Estimates for 2014 are $28.3 billion in revenue, and an EPS of ~$3.78, the latter of which represents a gain of 2.4%. The $14.6 billion market cap company has total cash, operating cash, and levered cash of $1.26 billion, $2.36 billion and $1.58 billion, respectively--healthy multiples for a strong executer.

Macy’s average growth is higher than the industry average. And, fortunately, this is complemented by an operating margin of 9.4%, which is quite high compared to the industry’s average of 3.7%. Debt-to-equity of 1.2 is also below the industry’s 1.3 average. Like many other retailers, during Christmas Macy’s kept its stores open for 48 straight hours to attract last minute customers.

There are several other reasons to be optimistic. First, its upper middle income appeal will enable it to thrive in a fully recovered economy. Macy's shoppers aren't as negatively impacted by higher payroll taxes compared to department stores targeting lower-income shoppers. This is a point that Macquarie analyst Liz Dunn agrees with, though for slightly different reasons. You may be asking yourself: "Why not buy Nordstrom (NYSE: JWN) if your intent is on betting on income demographics?" Nordstrom, which targets even more affluent shoppers than Macy's does, would be a perfect way to bet on a full recovery, but much of the upside has already been factored into the stock price. It trades at a respective 16.9x and 14x past and forward earnings versus 12x and 10.2x for Macy's.

A Look at JC Penney (NYSE: JCP)

JC Penney is a chain of 1,107 department stores that has been undergoing something of a "turnaround." Only it hasn't really been "turning around" in the sense that it has failed to produce solid results. Since rolling out the "New JCP" concept, the collection of boutique stores has delivered greater profitability. It has average sales of $269 per square foot versus the traditional $134 per square foot for the main store. The problem is that the "New JCP" is either cannibalizing the overall business or just not working--sales have fallen more than 30% over the holiday selling season. It is particularly noteworthy that this poor financial result came amidst aggressive price cutting.

Worse yet, JC Penney has negative momentum right now. UBS set the tone with its "sell" rating on January 11. Losses have double to triple what was anticipated relative to consensus, and this is particularly depressing since just last year the company churned a profit. Same-store sales have gone down by a rate of 26.1%. Revenue fell in the third quarter to $2.92 billion, which was far below the $3.23 billion that experts forecast. Worse still, gross margin dropped from 37.4% to 32.5%.

A prominent analyst Brian Sozzi said that JC Penney is not and may not become a relevant destination for customers in peak season. The company has tried to overcome the current economic challenges by cutting down on costs, but analysts say that this is not a long-term solution against a bleeding customer base. JC Penney has experimented with a back to school promotion by offering free haircuts to kids, but it all comes across as just very gimmicky. This is the perfect instance where it makes sense to "not bet against the tape."

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