Thursday's Top Upgrades (and Downgrades)

This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, as the U.S. Commerce Department laments a seasonally adjusted 0.4% decline in retail sales in the U.S., we'll take a look at a few recommendations from Nomura Securities on how to play the news. Nomura is advising investors to buy Tiffany (NYSE: TIF  ) on the high end of retail and Wal-Mart (NYSE: WMT  ) on the low, but thinks that it's...

Probably time to sell J.C. Penney
"Bad" news first. Last week, department store chain J.C. Penney (NYSE: JCP  ) told investors to expect 2% same-store sales growth when it reports earnings later this month. Wall Street initially reacted poorly to the news, selling off Penney stock, but over the past week, a miracle happened. Despite no new good news appearing to support the stock, Penney shares soared 17% to a recent high near $6.

Crazy? No doubt. But according to Nomura, this remarkable rise in Penney shares is a gift horse whose teeth need no examining. Warning that "a sales and market share recovery will take much longer than many may anticipate," and that "the J.C. Penney customer has migrated to other department stores and off-price retailers" and won't soon return, Nomura is recommending that investors get while the getting is good, and "reduce" their positions in the stock before any more bad news surfaces.

I agree. Over the past 12 months, J.C. Penney has burned through $2.5 billion in free cash flow, and booked GAAP losses of $8.66 per share. The shares themselves are worth less than Penney lost last year! Meanwhile, Nomura expects nearly as poor results in the current year -- a $3-per-share loss on further revenue declines.

Simply put, this company is a hot mess, and more likely to go under than to go up -- and Nomura is right to downgrade it.

Tiffany is shiny
In contrast, way up at the far end of the retail chain, Nomura sees great things ahead for Tiffany investors. Initiating coverage of the high-end jeweler with a buy rating and a $100 price target, Nomura argues that "after its encouraging performance in 2013, Tiffany is well positioned for another year of solid momentum, achieving perhaps $3.76 per share when 2013 earnings come out, and then growing that a further 14% to $4.30 per share in 2014."

Quoted on StreetInsider.com today, Nomura praises Tiffany's decision to implement its "first price increases in more than a year," and predicts that the company will "slowly and methodically increase price points" going forward, growing profits in tandem.

But here's the thing: At a P/E ratio of 24.5, the "price point" on Tiffany's stock already seems to take this profits growth for granted. More than that, I'd argue that 24.5 times earnings is too much to pay for the 14% growth that Nomura sees happening this year, and much too much to pay for the 12% long-term growth that is the consensus among analysts who follow the company. The more so because, judging from the company's cash flow statements, Tiffany's quality of earnings is not especially high.

Over the past year, the company has generated barely $301 million in real free cash flow, despite reporting earnings of nearly $465 million. That's about $0.65 in cash profits for every $1 of claimed "earnings." And it's the key reason I'm ignoring Nomura's advice on Tiffany and avoiding this stock.

Time to roll back into Wal-Mart?
And finally, shifting back toward the low end of the retail spectrum, we end with Wal-Mart -- and a situation similar to what we see at Tiffany, but worse.

Priced at 14.5 times earnings, Wal-Mart looks at first glance a lot cheaper than Tiffany, I'll admit. But looks are deceiving here for a couple of reasons. Unlike Tiffany, Wal-Mart carries a boatload of debt on its books -- about $53 billion net of cash. Like Tiffany, it's having real trouble converting its GAAP earnings into the kind of cash it would need to pay down that debt. Earnings for the past year totaled $17.2 billion at Wal-Mart, but free cash flow came to just $9.5 billion -- about $0.55 on the earnings dollar.

Even if Wal-Mart's valuation didn't already look egregiously out of whack at 14.5 times earnings on a projected 8.5% growth rate (which it does), and even if the company were not wallowing in debt (which it is), that free cash flow number would be enough to scare me away from the stock.

And as for Nomura's suggestion that the stock's a buy and will hit $85 within a year thanks to "e-commerce business and an uptick in traffic in the U.S. stores?" Sorry. I don't buy it.

Motley Fool contributor Rich Smith has no position in any stocks mentioned, and neither does The Motley Fool.

 


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  • Report this Comment On April 30, 2014, at 1:55 PM, longjcptoppick wrote:

    J.C. Penney rises after positive comments from Calvin Klein parent

    Shares of retailer J.C. Penney (JPC) are rising after apparel maker PVH Corporation (PVH) stated at a conference that it feels its business at J.C. Penney is strong and running "ahead of time." PVH’s portfolio of brands includes Calvin Klein, Tommy Hilfiger, Van Heusen, and Izod. WHAT'S NEW: During its presentation at a retail conference hosted by Nomura earlier today, PVH's Chairman and CEO Manny Chirico said that the company's business is "pretty strong" right now at J.C. Penney and is "running ahead of plan." He said that in the dress furnishings inventory, the retailer has inventory levels back to where they "should have been." Chirico also said the company's Van Heusen and Izod sportswear business are "very strong" at J.C. Penney and they have also been running ahead of plan there. He said that based on the trends that PVH saw on the Men's side of the business, those brands seem to be performing at a much higher level. While Chirico said he can't make a broad statement, he believes the company's business is comping positively. The CEO added that he expects more positive results from its brands at J.C. Penney and the company is encouraged by everything it has seen over the last 4 to 5 months at the retailer. WHAT'S NOTABLE: Also during the Nomura conference, PVH's Chirico commented on the company as a whole by saying that with some better weather there is some pent-up demand that's coming. PVH's challenge for Q1 into Q2 will be more on the margin line and, as a whole, the company is in a good position competitively versus last year, the executive added. PRICE ACTION: During late morning trading, shares of J.C. Penney are up 60c, or 7.5%, to $8.58, while PVH shares are up 1% to $123.52.

  • Report this Comment On April 30, 2014, at 1:58 PM, longjcptoppick wrote:

    I also see JCP passing M this year. you have to see the huge New JCP store off the belt pk.. a state of art.. lot of projects and lot of traffic and people... this is a winner JCP will be the best retailer from here. Garanteed to see the old jcp price target of $87.00 this year... SUGGEST to all ignor bashers and all that try to conter this message.. BE LONG JCP.. $22.50 coming target. jcp.

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