After reading the Barron’s headline from Feb. 24, “Down Go the Department Stores as Dillard’s Disappoints,” you might think that the department store was going to hell in a handbasket.
Well, that’s only partially true — department stores are suffering the same fate as the rest of retail. Very few Q4 earnings reports have lit the world on fire. Routinely generating near-double-digit quarterly same-store sales growth is a thing of the past.
Everyone is feeling the heat at the moment. And that’s okay. Retail, like many other industries, is a cyclical business full of good times and bad. Right now, you’d have to characterize its business as mediocre. Not good, but not horrific.
There are two department stores that will weather the storm: Nordstrom (JWN) and Macy’s (M). I’ll tell you why you should consider owning them. A third, JCPenney (JCP), is definitely not a stock you’ll want to bet your retirement on, but presents a very interesting risk-to-reward proposition. Over the next 12-18 months, I see all three making moves of 20% or more.
International Expansion — JWN Stock
The Nordstrom brothers are likely watching Target’s (TGT) aggressive expansion into Canada with interest. Most experts would agree that the Minneapolis discounter has fumbled its opportunity to capture some of Walmart’s (WMT) business. It has lost nearly one billion dollars since opening its doors last March. However, we’re just now approaching Target’s one-year anniversary in Canada. It’s not how you start that matters; it’s how you finish.
What does this mean for JWN Stock?
Like Target, the long-term prognosis for Nordstrom in Canada is very favorable despite the competition it will face from Saks, a subsidiary of the Hudson’s Bay Company (HBAYF), Canada’s largest department store. Never has Canada’s retail scene experienced such dynamic change. Nordstrom is one of the major beneficiaries.
Several analysts have downgraded JWN stock since it reported Q4 earnings Feb. 20. Earnings were a mixed bag. More worrisome to investors was its 2014 guidance that calls for top-line revenue maxing out at $13.5 billion with earnings per share of $3.90.
While revenue was in line with analyst projections for JWN stock, its EPS at the high end of the range was 11 cents lower than the consensus estimate. Costs related to its Canadian expansion and an ongoing promotional environment are responsible for the lowered projections.
I like JWN stock for two main reasons: First, I think its Canadian expansion will be a hit from the start. These department stores will be wonderful, and no amount of competition is going to change that. Secondly, its e-commerce business now generates 33% of its overall revenue, growing at a quarterly rate of 30% or more. It might cannibalize revenue, but ultimately it will make a lot more money for the company just as Williams-Sonoma (WSM) does with its online business.
In the end, JWN stock wins because Nordstrom provides the best customer experience in-store and online.
Best-Performing Stock — M Stock
Macy’s (M) shareholders have had a spectacular year, up 42% over the past 52 weeks through Feb. 27. That’s 30 percentage points higher than its department store peers and 20 percentage points better than the S&P 500.
By any comparison, owners of M stock can’t complain. Since Terry Lundgren became CEO, M stock has achieved an annualized total return of 16.6% — 690 basis points higher than the SPDR S&P 500 (SPY). Lundgren has done well for himself over the past 11 years as CEO, and so have M stock holders.
M stock expects 2014 same-store sales growth between 2.5% and 3%. Its bottom-line earnings should be between $4.40 and $4.50 per share. While it is investing almost $1.1 billion in its business in 2014, it’s also laying off 2,500 employees in an effort to save $100 million annually.
It might seem odd that a company that generates almost $2 billion in free cash flow would need to downsize, but clearly investors liked the move. M stock is up almost 12% since the Jan. 8 announcement.
While you can’t go wrong owning M stock, I think there are several factors that make Nordstrom a slightly better buy. The biggest being that Nordstrom generates almost three times as much business on a percentage basis as Macy’s does from its online operations. The higher the price point, the higher the potential profit when selling online. However, Macy’s brick-and-mortar department stores actually did better than Nordstrom’s full-line stores in 2013.
On a valuation basis, despite the 42% gain over the past year, M stock is likely a better buy if you’re looking for a short-term momentum play over the next six months. Past that, JWN stock easily outperforms Macy’s.
Risk/Reward — JCP Stock
Nobody in their right mind would suggest placing your life savings in JCP stock. However, if you’ve got $10,000 to spare, I think JCPenney’s Q4 results provide enough good news to warrant serious consideration. The risk-to-reward proposition has probably never been greater than it is right now.
The last time JCP stock traded around $7 was back in the Reagan years — 1981 to be precise. JCPenney’s annual revenues back then were around $12 billion, almost identical to where they were in 2013.
As I pointed out prior to JCP stock releasing its Q4 earning,s there are several things it needs to do over the next 12-18 months in order for JCP stock to move higher. And, for most of those items, it’s doing a good job:
- The company is showing improvement in gross margins. In Q4 2013 they were 28.4% — 460 basis points higher than in Q4 2013
- Online sales are critical to the success of any retailer, and JCP’s online sales were $381 million — 26% higher than in the same period last year.
- It’s too early to tell how St. John’s Bay and other private label brands are doing, but CEO Mike Ullman did say in the conference call that JCP customers have been very enthusiastic about St. John’s Bay once again becoming an important part of the company’s offerings.
- JCP finished the year with total liquidity of $2.02 billion. If the turnaround is completed in 2014, JCP stock expects to generate positive free cash flow for the year. That’s very good news.
- While JCP delivered 2% positive comps in Q4, Sears Holdings (SHLD) was busy pulling negative comps of 6.4%. Any more improvement by JCP on a merchandising front will result in JCP stock taking market share from Sears.
No, things aren’t perfect. But Mike Ullman has JCPenney moving in the right direction. If that keeps up, JCP stock will eventually trade in double digits. Beyond that, with a little luck, it will be into the 20s by the middle of 2015. Pretty good prospects for a stock that seemed dead just a year ago.
As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.