With a difficult, highly promotional holiday season behind us, retailers have started reporting lackluster earnings for the holiday quarter. Many retail stocks have taken a beating, with the S&P Retail ETF down nearly 9% so far this year, driven by fears of both weak spending on the part of consumers and further shifts to e-commerce.
Sifting through the carnage, there are two retail stocks, Best Buy (BBY 2.83%) and Staples (SPLS), that have fallen into value territory, while a third retailer, J.C. Penney (JCPN.Q), looks like it should be avoided at all costs.
The Best Buy overreaction
Shares of Best Buy had an incredible run in 2013, more than tripling from decade lows, but the new year has brought with it a complete collapse of the stock. After reporting an unexpected decline in same-store sales for the holiday season, the market panicked, sending the stock down more than 25% in a single day.
It's almost funny how quickly sentiment changed after the announcement, with articles predicting Best Buy's inevitable demise popping up everywhere. This reminds me of the end of 2012, when Best Buy was trading near $12 per share and finding an article that wasn't all doom and gloom was almost impossible. The long-term story at Best Buy hasn't changed, and while the results were disappointing, there's no reason to panic.
Best Buy has become a leaner and more efficient company over the past year, removing $550 million in annual costs as part of its "Renew Blue" initiative. There's still $175 million in costs left to remove before the company reaches its stated target, but CEO Hubert Joly stated in the holiday sales release that the company would be focusing on quicker and deeper cost cuts in the coming year. Every dollar that Best Buy can remove from its cost structure allows the company to be more effective in contending with online competitors like Amazon.com, and the progress so far has been impressive.
Best Buy will still turn a profit during the fourth quarter, with a non-GAAP operating margin of around 4% expected. While this is lower than previous guidance, the fact that Best Buy remained profitable in what was a very tough holiday season is a testament to how far the company has come.
Staples once again looks cheap
Shares of Staples have declined by more than 15% year-to-date, and even though the company has had trouble growing revenue lately, the stock looks like a real bargain. Staples is the leading office-supply company as well as the second-largest Internet retailer, and while demand for traditional office supplies is declining, Staples has been adding new categories in an attempt to become a one-stop shop for businesses.
Staples now trades at less than 10 times its expected annual free cash flow, and with a dividend yielding 3.6% and an active share-buyback program, the company is putting that cash flow to use. That's not to say that Staples isn't investing in the future, with the recent acquisition of tech start-up Runa part of Staples' push to offer a more personalized e-commerce experience. While pessimism regarding traditional retailing has pushed shares of Staples down, the company has been fully embracing the e-commerce channel, and that should help Staples return to growth sooner rather than later.
J.C. Penney looks more doomed than ever
While many were betting on a Best Buy-style turnaround for J.C. Penney, the company is in such a deep hole that it seems unlikely that it can survive, let alone return to profitability. Management failed to provide any numbers when it reported holiday sales, and investors took that as a sign that the results were dismal. The market capitalization of J.C. Penney is now below $2 billion, with the stock losing more than 90% of its value since the decade-high in 2007, and the turnaround story is getting harder to believe every day.
J.C. Penney has a very limited amount of time before it runs out of options, with debt piling up and huge interest payments acting as a barrier to profitability. Not only does J.C. Penney need to return to operational profitability, it needs to become profitable enough to actually service its debt. We'll have to wait until late February before learning how it fared over the holidays, but if the company's silence is any indication, I wouldn't expect good news.
The bottom line
The sell-off in retail stocks has pushed both Best Buy and Staples down to attractive levels. Both companies have advantages, with Best Buy being the only national consumer-electronics retailer left standing and Staples having a huge e-commerce lead over competitor Office Depot. J.C. Penney, on the other hand, has failed to lure customers back into stores, and with so many other options available to consumers, I don't see how J.C. Penney returns to relevance from here.