U.S. Retailers: 3 Companies and Only 1 Long Opportunity

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

The multi-line retail industry is very competitive. How a firm creates value relative to other players is crucial to determine profitability in the long run. In this article, we try to determine what department store stocks the investors should buy.

The premium leader

Macy's (NYSE: M) is a retail company operating stores and internet websites that sell a range of merchandise. Macy's Chief Financial Officer said to investors that the strategies implemented will continue in the future. The company is focused on three aspects: merchandise planning to generate long-term profitability, capital allocation trough the stock buyback program, and the rapid growth of e-commerce.  

I would advise investors to focus on Macy's, as this company shows strong fundamentals:

  • Operating Margin of 9.6%, higher than the industry median of 4.2%
  • Net Margin of 4.8%, higher than the industry median of 2.8%
  • Return on Equity (ROE) of 22.1%, higher than 87% of companies in the industry
  • Return on Assets (ROA) of 6.4%, expanding the last four years
  • Return on Capital (ROC) of 28.7%, doubling the industry median

In terms of valuation, the stock sells at a current P/E of 14.3 times, trading at a discount compared to an industry average of 16.5. Analysts’ expectations imply a forward P/E of 11, also trading at a discount to peers. With respect to the P/B ratio, 3.2 indicates a discount compared to the industry average of 3.4, and an interesting upward trend.

With respect to financial analysis, we can highlight that in the first quarter of 2013, Macy’s experienced growth in revenue and net income. Due to the lower number of total shares outstanding, its earnings per share (EPS) growth was 27.9%, from $0.43 per share to $0.55 per share, compared to the same quarter a year ago, better than the consensus estimate of $0.53. The company has demonstrated a positive pattern of EPS growth over the past three years, and it is expected that this upward trend will continue.

Reshaping strategy, high performance relative to comps

Target (NYSE: TGT) operates general merchandise stores in the United States. The company operates in three segments: U.S. retail, U.S. credit card, and Canadian. Although Target's primary growth drivers are new store openings in the U.S., the company has to restate the strategy of differentiation because competition is fierce.

The metrics shown below are better in comparison to the industry, but they all show a downward trend since 2011.

  • Operating Margin of 7.3%, higher than the discount stores industry median of 3%
  • Net Margin of 4.1%, higher than the industry median of 1.8%
  • Return on Equity (ROE) of 18.1%, higher than 83% of the companies in the industry
  • Return on Assets (ROA) of 6.2%, higher than 71% of the companies in the industry

In the last earning report, the company showed that revenue dropped by 0.9%, and this led to a decrease in EPS of 26%. However, the stock is now trading at a higher level compared to a year ago.

Weak fundamentals to remain in place

J.C. Penney (NYSE: JCP) operates department stores in the U.S. Given the company's weak fundamentals, and its recently failed turn-around strategy, I would advise investors not to focus on J.C. Penney for the time being. Its main figures are weak: 

  • Operating Margin and Net Margin are negative and significantly below the industry average
  • Return on Equity (ROE) has decreased when compared to the same quarter one year prior
  • Cash to debt ratio of 0.3% could indicate deteriorating cash flow and liquidity risks going forward

Moreover, valuation is still not attractive. I would only go long on J.C. Penney if its P/B ratio, currently at 1.3 times, would go below 0.8 times. The company has a huge real estate asset base that could make it attractive if it was selling at a significant discount to book value. 

Conclusion

Macy's is the best pick considering the company's out-performance of the stock market. Its strengths can be seen in EPS and revenue growth, increase in net income, and high ROE. Comparisons to Target make Macy's shares look undervalued, considering a ROE of 22.1% versus 18.1% and a P/E ratio of 14.3 times versus 16.5 times. Paul Tudor Jones and Jim Simons also invested in this stock in the last quarter, and i would follow them if I was looking for any stock within the retailer's space.

J.C. Penney’s stock cratered under Ron Johnson’s leadership, but could new CEO Mike Ullman present the opportunity investors have been waiting for? If you're wondering whether J.C. Penney is a buy today, you're invited to claim a copy of The Motley Fool's must-read report on the company. Learn everything you need to know about JCP's turnaround -- or lack thereof. Simply click here now for instant access.


Vanina Egea 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!

blog comments powered by Disqus