Should You Buy J.C. Penney, Sears, or Nordstrom?

J.C. Penney, Sears, and Nordstrom offer plenty of variety for investors looking for alternatives among department store stocks.

May 27, 2014 at 9:34AM

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Department stores are going through difficult times, but that doesn´t mean investors should necessarily stay away from the sector. Companies such as J.C. Penney (NYSE:JCP), Sears Holdings (NASDAQ:SHLD), and Nordstrom (NYSE:JWN) offer plenty of variety to choose from for those interested in investing in this retail space.

J.C. Penney: The turnaround candidate
J.C. Penney stock rose by an explosive 57.45% in the last quarter as investors reacted with optimism to the company´s improving financials. The long-troubled retailer may not be completely out of the woods yet, but it´s clearly moving in the right direction.

Sales during the company's fiscal 2014 first quarter grew 6.3% to $2.8 billion, versus $2.6 billion in the same quarter last year, and better than analysts' forecast of $2.7 billion. Same-store sales increased 6.2%, which was above the company's own guidance for an increase of between 3% and 5%.

J.C. Penney is making significant progress via initiatives such as closing unprofitable stores and improving merchandise assortments. Private brands like St. John's Bay, Worthington, Stafford, J. Ferrar and Xersion are outperforming, according to management, so the company is regaining some of the ground it lost to competition in recent years.

Profitability is on the rise, too: J.C. Penney reported a 230-basis-point increase in gross margin during the last quarter, to 33.1% of sales, while operating loss shrunk by 49.2% versus the same period in the prior year.

Although the risks are still considerable, the situation is clearly improving for J.C. Penney investors, and the stock offers ample room for appreciation if management continues leading the company on the right track.

Sears is on sale: buying opportunity or damaged merchandise?
Things have not looked well for Sears investors lately as the company has faced declining sales profits over the last several years, and recent earnings reports show no sign of reversal in the trend.

Revenue during the quarter ended on May 3 declined 6.8% to $7.9 billion, versus $8.4 billion in the same period last year. Comparable-store sales at Sears' domestic branch declined 0.2%, while comparable-store sales at Kmart fell 2.2%.

Furthermore, profit margins continue to deteriorate at Sears. Gross margin declined to 23.2% of sales versus 25.5% in the year-ago quarter, while SG&A expenses as a percentage of sales rose from 26.2% to 26.5%.

Sears trades at a price-to-sales ratio of 0.11, materially cheaper than both J.C. Penney and Nordstrom, which are respectively valued at ratios of 0.23 and 1.02. This means the stock offers enormous upside potential if management can stabilize revenue and improve profitability.

However, that´s a huge if. Sears is a highly indebted company losing lots of money and facing declining sales. In the absence of any sign of a sustainable turnaround in financial performance, the risks may outweigh the opportunity in this ailing retailer.

Nordstrom offers superior quality
Nordstrom has proven to be a high-quality play in the sector over the long term. The company has generated remarkable performance through good and bad economic times, and last quarter was no exception.

During the period ended on May 3, Nordstrom generated a sales increase of 6.8% versus the same quarter in the prior year, to $2.8 billion. Comparable-store sales increased by a healthy 3.9%. Unlike J.C. Penney, Nordstrom is not facing easy comparisons due to depressed sales levels in the prior year, and this makes the company's performance look even more impressive.

Nordstrom Rack has been a big success for the company lately. Overall sales increased by a whopping 20% annually due to 27 new store openings and a jump of 6.4% in Nordstrom Rack same-store sales. Nordstrom is also heavily investing in technology and e-commerce, which is generating solid results for the company as direct sales increased by 33% on an annual basis during the last quarter.

Investors looking for a top-notch player among department stores, with a proven track record of success and rock-solid fundamentals, should look no further than Nordstrom

Foolish takeaway
J.C. Penney is clearly making progress in its turnaround efforts, while still offering substantial upside potential if things continue going well. Nordstrom is an exceptional high-quality player in the department stores business. Sears could be the ultimate contrarian bet, but the company's situation continues to deteriorate, so the risks are high. For investors looking to go shopping for department store stocks, there is plenty of variety to choose from on the rack.

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