Better Buy: J.C. Penney Company, Inc. vs. Kohl's

The retail sector can be a high-risk area in which to invest. E-commerce is disrupting a huge swath of the industry, and many brick-and-mortar retailers are suffering plunging sales and profits in the wake of intensifying competition from online rivals.

But with the prices of many retailers down sharply in recent years, could there be some interesting bargains for investors? In this regard, let's take a look at Kohl's (KSS 2.55%) and J.C. Penney (JCPN.Q) to see which of these retailers is the better buy today.

With their prices slashed, some retailers' stocks are now in the bargain bin. Image source: Getty Images.

Competitive position

One of Kohl's primary competitive advantages is that its stores are typically located in strip malls and stand-alone locations. These areas are generally enjoying better traffic trends than larger indoor malls. Nevertheless, Kohl's is rationalizing its square footage, including converting some of the selling space in its stores into digital fulfillment areas. This has helped to improve margins by reducing inventory and selling costs, while having a minimal impact on sales. Moreover, Kohl's is looking to sublease space to grocery and convenience stores. The company believes this can help to further cut costs, boost traffic, and provide a new rental income stream.

Additionally, Kohl's is taking the rather unorthodox approach of partnering with e-commerce juggernaut Amazon.com (AMZN 1.38%). The two companies launched a pilot program in which select Kohl's stores will sell Amazon-branded electronics such as its popular Echo devices. Kohl's is even going as far as to accept returns of items purchased on Amazon.com at some of its stores. And it's possible that this pilot program could lead to a more comprehensive partnership with Amazon; some analysts believe that Amazon could lease space from Kohl's for its new Go grocery store concept.

The retailer is also rumored to be a potential acquisition target for Amazon, and Kohl's is arguably doing everything in its power to make that scenario more likely. Regardless of whether a buyout materializes, Kohl's strengthening partnership with Amazon does make it somewhat more insulated from the threat of e-commerce.

J.C. Penney, meanwhile, is one of the retailers most exposed to the decline of indoor malls. In fact, many of its stores are located in Class B and C malls, which are enduring some of the worst traffic and sales declines. Still, J.C. Penney does have some things working in its favor, namely the struggles of its competitors. For instance, the department store has added more toys to its merchandise after the bankruptcy of toy store chain Toys R Us. An even bigger opportunity lies in home goods; as rival retailer Sears is forced to sell off stores, J.C. Penney is ramping up its assortment of appliances, furniture, and mattresses. Sales of these items surged approximately 30%, 40%, and 60%, respectively, during the fourth quarter. And with Sears likely headed to a similar fate as Toys R Us, J.C. Penney should continue to benefit.

However, while J.C. Penney will no doubt profit from the troubles of these beleaguered retailers, it's unclear whether these gains will amount to anything more than just a short-term bump. That's because retail sales continue to migrate toward online channels and away from the malls in which so many J.C. Penney stores are based. Kohl's off-mall locations and partnership with Amazon place it in a stronger competitive position in this regard.

Advantage: Kohl's

Financial position

Let's now take a look at how these retail rivals stack up in regard to financial strength.

Data sources: Morningstar, Yahoo! Finance.

From revenue to profits to cash flow generation, Kohl's has a sizable advantage over J.C. Penney. And while J.C. Penney's cash reserves are dwindling, Kohl's is flush with more than $1.3 billion in cash on its far stronger balance sheet. Thus, Kohl's has a clear edge when it comes to financial fortitude.

Advantage: Kohl's 

Growth

Store closures and waning customer traffic have made it difficult for Kohl's and J.C. Penney to deliver much in the way of revenue growth in recent years.

KSS Revenue (TTM) data by YCharts

Wall Street expects more of the same in the coming years. Analysts project that Kohl's revenue will inch up 0.4% in fiscal 2019 and 1.1% in 2020. Meanwhile, J.C. Penney's sales are forecasted to fall 2.8% in 2019 and remain essentially flat in 2020. Kohl's, however, is expected to increase its earnings per share by nearly 9% annually over the next half-decade, fueled by its inventory management and store productivity initiatives. For J.C. Penney, though, simply generating consistent GAAP profits will likely remain challenging. So here, too, the edge goes to Kohl's.

Advantage: Kohl's

Valuation

No better-buy discussion should take place without a look at valuation. Let's check out some key value metrics for J.C. Penney and Kohl's, including price-to-sales, price-to-free cash flow, and price-to-earnings ratios.

Data source: Yahoo! Finance, Morningstar.

J.C. Penney's shares are cheaper than Kohl's in terms of price-to-sales, while Kohl's is the better value on both a price-to-free cash flow and forward P/E basis. This makes sense, as Kohl's is the much more profitable business with an operating margin of 7.42% over the past year compared to only 2.18% for J.C. Penney. Profits and free cash flow are what we're after as investors, so these are the more important metrics from which to judge value. As such, Kohl's is the better bargain. 

Advantage: Kohl's

The better buy is...

All told, this better buy analysis turned out to be decidedly one-sided. With its stronger competitive position, greater financial fortitude, superior growth prospects, and more attractively priced stock, Kohl's is clearly the better long-term investment today.