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

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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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  • Report this Comment On May 27, 2014, at 12:11 PM, Roddy6667 wrote:

    Despite all the happy talk about JCP, nobody's spreadsheets show them making a profit in this decade. Improving sales and a better gross margin are offset by huge debt and an inefficient supply chain.

  • Report this Comment On May 28, 2014, at 6:44 AM, longjcptoppick wrote:

    J.C. Penney: In The Long Term, A Lot More Room To Run

    May. 22, 2014 11:33 AM ET | 90 comments | About: J.C. Penney Company Inc. (JCP)

    Disclosure: I am long JCP. (More...)

    Summary

    JCP's operations are beginning to hum.

    The sell-side and buy-side are not yet on board which is their mistake.

    The long-term free cash flow generating ability of the Company should be worth much more.

    I continue to be amazed at how J.C. Penney (JCP) the stock trades compared to JCP the business. Since the stock offering in the fall, the Company has stabilized and now grown comps in the face of severe industry headwinds, brought back private label and promotions which have improved margins, and guided to FCF neutral on the year. All of this in the face of a brutal retail environment. Bon-Ton Stores (BONT) by contrast just reported another weak quarter though they did manage 35%+ gross margins which is where JCP is headed this year as well if not better. JCP debt has responded by rocketing to the highs while the stock is well off its lows, it continues to trade well below the $9.65 offer price and the intrinsic value.

    20,279 people received this article by email alert

    Add your email to get alerts on JCP too:

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    Why the disconnect? I do believe that CEO, Mike Ullman, bears some of the blame. While I can not argue with his operational success if not genius in rapidly reversing the nosedive under Ron Johnson and credit the board for bringing him back in the face of withering criticism from Ackman, who resigned from the board and sold his stock over the issue of CEO control (among other things), I can fault Ullman's ability to manage the street and his stock price. From the ham-handed way the offering was handled to the two line holiday same store sales release that panicked investors that Christmas was a disaster when in reality it was on plan and one of the best showing of any department store chain. The 6-7% comp. in Q1 simply blew away expectations and left the bears scrambling for ways to knock the stock down. If Ullman is to be the permanent CEO, he must do more to manage investors and his stock price or he should go.

    Here is where the story gets interesting. The bears have been mostly using static analysis to say J.C. Penney was going bankrupt. There last two quarters and FCF neutral guide for year end tell you that is just not going to happen. A new credit line with an extra $500mm also tells you that equity dilution is far less likely if not a zero possibility. For most of the time since I started posting on JCP after the offering, the bears have been saying that Chapter 11 or massive dilution was inevitable and that JCP was stuck at $12 billion in sales and low 30s gross margins, never mind that every comp does mid to high 30s and that sales were $17 billion before Ron Johnson came on board.

    One thing to beware from the sell side and buy side commentators is a shift in story. The facts have clearly changed as even the most hardened bear will say that J.C. Penney is on the mend. The bear argument has now shifted to one of valuation which is a slippery slope since JCP is very cheap to its long-term earning power. Two of the biggest bears, Wells and Imperial are essentially using this argument to help the shorts and intercapital arbs cover in a bad macro tape at levels that are too cheap to be believed. For the last several quarters, Wells has been using JCP's good numbers and contorting the facts to say the Company is really still going bankrupt. Now that his theory has been blown out of the water (q4 and q1 results plus a 20 point drop in 5 year CDS to the mid teens from the mid 30s shows just how wrong Wells has been), the analyst has shifted to saying that the stock is overvalued. Valuation is more of an art and a science, but JCP appears to be on track to undo most of not all of the RJ damage. I am even running scenarios where the company actually gets to higher than $17 billion in sales, as it takes share from Sears (SHLD), Kohl's (KSS), Macy's (M) and BONT.

    What would a back to the future JCP look like? If JCP were to get back to $17 billion in sales and 39% margins which is where it was under Ullman before the RJ debacle (assuming no additional growth from the economy as they recapture share) and were able to keep SGA around $4 billion (it was bloated before that is one thing RJ got right and Ullman has continued), EBITDA goes to the $2.6 billion to $2.7 billion range by 2016. The Company pays off most if not all of its debt by then. A modest 6x multiple yields about $50 a share. If one looks at pretax free cash flow, the Company would generate about $7.35 a share, 10x that number is $75 for the stock. That is the money that the long-term bulls are playing for.

    I think this can happen by 2016, which gives Ullman 3-4 years. If it takes longer so be it, but the point I would make is as long as we are fcf neutral we have unlimited time for this to play out. Also it is obvious that JCP is taking share from bont, m, kss, shld, etc. based on the recent reports. The assumptions would be:

    Rev: 17003.308

    Gross Profit:6631.29

    SGA: 4000

    Net Debt: 0

    Multiple: 6x EV/EBITDA

    With 400mm of cap-ex, should generate about 7.35 of FCF per share This is why stock was in 30s even before Ackman.

    Bears will say that is impossible given where they are now, but bears have been calling for negative comps and near term bankruptcy and that looks silly now. These numbers are really just getting back to what JCP did under Ullman a few years ago with a lot of debt pay down and some SGA improvement and capital efficiency that they have already shown able to do. Who is really being more unrealistic? These numbers aren't even that exciting, what if JCP actually gets some of the sales productivity that Johnson and Ackman were dreaming of when they bought the stock in the 20s and 30s? Much higher numbers are possible.

  • Report this Comment On May 28, 2014, at 6:45 AM, longjcptoppick wrote:

    REASONS to BE LONG JCP--- remember JCP was always higher than MACY'S, SEARS,, TGT.. Till ceo left.. but now CEO is BACK.. and gaining all from here

    J.C. Penney: In The Long Term, A Lot More Room To Run

    May. 22, 2014 11:33 AM ET | 90 comments | About: J.C. Penney Company Inc. (JCP)

    Disclosure: I am long JCP. (More...)

    Summary

    JCP's operations are beginning to hum.

    The sell-side and buy-side are not yet on board which is their mistake.

    The long-term free cash flow generating ability of the Company should be worth much more.

    I continue to be amazed at how J.C. Penney (JCP) the stock trades compared to JCP the business. Since the stock offering in the fall, the Company has stabilized and now grown comps in the face of severe industry headwinds, brought back private label and promotions which have improved margins, and guided to FCF neutral on the year. All of this in the face of a brutal retail environment. Bon-Ton Stores (BONT) by contrast just reported another weak quarter though they did manage 35%+ gross margins which is where JCP is headed this year as well if not better. JCP debt has responded by rocketing to the highs while the stock is well off its lows, it continues to trade well below the $9.65 offer price and the intrinsic value.

    20,279 people received this article by email alert

    Add your email to get alerts on JCP too:

    Get email alerts on JCP »

    Why the disconnect? I do believe that CEO, Mike Ullman, bears some of the blame. While I can not argue with his operational success if not genius in rapidly reversing the nosedive under Ron Johnson and credit the board for bringing him back in the face of withering criticism from Ackman, who resigned from the board and sold his stock over the issue of CEO control (among other things), I can fault Ullman's ability to manage the street and his stock price. From the ham-handed way the offering was handled to the two line holiday same store sales release that panicked investors that Christmas was a disaster when in reality it was on plan and one of the best showing of any department store chain. The 6-7% comp. in Q1 simply blew away expectations and left the bears scrambling for ways to knock the stock down. If Ullman is to be the permanent CEO, he must do more to manage investors and his stock price or he should go.

    Here is where the story gets interesting. The bears have been mostly using static analysis to say J.C. Penney was going bankrupt. There last two quarters and FCF neutral guide for year end tell you that is just not going to happen. A new credit line with an extra $500mm also tells you that equity dilution is far less likely if not a zero possibility. For most of the time since I started posting on JCP after the offering, the bears have been saying that Chapter 11 or massive dilution was inevitable and that JCP was stuck at $12 billion in sales and low 30s gross margins, never mind that every comp does mid to high 30s and that sales were $17 billion before Ron Johnson came on board.

    One thing to beware from the sell side and buy side commentators is a shift in story. The facts have clearly changed as even the most hardened bear will say that J.C. Penney is on the mend. The bear argument has now shifted to one of valuation which is a slippery slope since JCP is very cheap to its long-term earning power. Two of the biggest bears, Wells and Imperial are essentially using this argument to help the shorts and intercapital arbs cover in a bad macro tape at levels that are too cheap to be believed. For the last several quarters, Wells has been using JCP's good numbers and contorting the facts to say the Company is really still going bankrupt. Now that his theory has been blown out of the water (q4 and q1 results plus a 20 point drop in 5 year CDS to the mid teens from the mid 30s shows just how wrong Wells has been), the analyst has shifted to saying that the stock is overvalued. Valuation is more of an art and a science, but JCP appears to be on track to undo most of not all of the RJ damage. I am even running scenarios where the company actually gets to higher than $17 billion in sales, as it takes share from Sears (SHLD), Kohl's (KSS), Macy's (M) and BONT.

    What would a back to the future JCP look like? If JCP were to get back to $17 billion in sales and 39% margins which is where it was under Ullman before the RJ debacle (assuming no additional growth from the economy as they recapture share) and were able to keep SGA around $4 billion (it was bloated before that is one thing RJ got right and Ullman has continued), EBITDA goes to the $2.6 billion to $2.7 billion range by 2016. The Company pays off most if not all of its debt by then. A modest 6x multiple yields about $50 a share. If one looks at pretax free cash flow, the Company would generate about $7.35 a share, 10x that number is $75 for the stock. That is the money that the long-term bulls are playing for.

    I think this can happen by 2016, which gives Ullman 3-4 years. If it takes longer so be it, but the point I would make is as long as we are fcf neutral we have unlimited time for this to play out. Also it is obvious that JCP is taking share from bont, m, kss, shld, etc. based on the recent reports. The assumptions would be:

    Rev: 17003.308

    Gross Profit:6631.29

    SGA: 4000

    Net Debt: 0

    Multiple: 6x EV/EBITDA

    With 400mm of cap-ex, should generate about 7.35 of FCF per share This is why stock was in 30s even before Ackman.

    Bears will say that is impossible given where they are now, but bears have been calling for negative comps and near term bankruptcy and that looks silly now. These numbers are really just getting back to what JCP did under Ullman a few years ago with a lot of debt pay down and some SGA improvement and capital efficiency that they have already shown able to do. Who is really being more unrealistic? These numbers aren't even that exciting, what if JCP actually gets some of the sales productivity that Johnson and Ackman were dreaming of when they bought the stock in the 20s and 30s? Much higher numbers are possible.

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