Mergers have become a popular turnaround strategy for mature department-store chains -- witness Sears Holdings (NASDAQ:SHLD) combining Sears and K-Mart, or Federated Department Stores (NYSE:FD) merging with May Department Stores. J.C. Penney (NYSE:JCP), on the other hand, decided to go it alone to revive its brand, growth strategy, and profitability. Things have worked out nicely for the company and investors over the past four years. But what's in store for Penney's going forward?
Judging by recently reported first-quarter earnings, improvements are progressing quite favorably. For the quarter, J.C. Penney reported that total department-store sales grew 2.2%, while same-store sales grew 1.3%. This represented the 12th consecutive quarter of positive comps. Gross margins increased 80 basis points to 41.9%, and operating profits increased 120 basis points to 8.7%. Reported earnings were $0.90, a 45% increase from the first quarter of 2005. Though net income increased only 22%, earnings-per-share growth was higher due to a smaller amount of shares outstanding.
Management offered Q2 guidance for a low-single-digit increase in comparable sales and earnings per share "in the area of" $0.60. Full year guidance called for a range of $4.24-$4.34 per share in operating earnings.
Penney's operated 1,021 stores as of the end of April in the U.S. and Puerto Rico. Competition is formidable, since the company must go up against old-line retailer Sears and the faster-growing, more popular large chains such as Target (NYSE:TGT), Wal-Mart (NYSE:WMT), and Kohl's (NYSE:KSS). The newer guys are growing faster, with more convenient locations and better selections. They offer more competitively priced products, thanks to economies of scale and more efficient distribution models. In short, they have been eating the lunch of old-line retailers such as Penney's. But the old kids on the block have at least started to fight back, as witnessed by industry consolidation and turnarounds.
Over the past five years, sales growth at Penney's has been miserable, falling about 10% annually. Yet earnings have grown about 60% each year on average over that time frame, albeit from a depressed base. Profitability has improved immensely, and management has used cash from the sale of the Eckerd drugstore chain to repay debt. J.C. Penney's growth strategy entails adding non-mall locations to reach consumers who have become accustomed to shopping at Target or Wal-Mart.
So what can Fools expect going forward? Clearly, the easy money has been made; J.C. Penney's stock has increased to a current $64.45, roughly quadrupling from lows near $15 in mid-2003, when doubt regarding the success of the announced turnaround peaked. The company still has room for store expansion and greater cost savings, and it can use excess cash flow to repurchase shares, as witnessed by management's intent to complete an authorized repurchase program by year's end. But by investing in J.C. Penney's stock today, could we miss out on better opportunities?
If you're looking to invest in department stores, it helps to think of the opportunity cost -- the simple risk of missing out on better investments. With a trailing P/E of just 15.3, and projected forward P/E just under 13, J.C. Penney isn't too expensive compared to rivals. Target currently trades slightly below 20 times trailing earnings, while Kohl's trades at 23 times and Wal-Mart at 18.
In my opinion, investors aren't paying too much of a premium for names with more compelling growth outlooks, both near-term and over the next five to ten years. For more on these names, check out what Stephen D. Simpson had to say about Target's results, or our Foolish Forecast on Wal-Mart's earnings, which are due out on Wednesday. Things have improved for J.C. Penney, but not enough for me to pass up a chance to invest in faster-growing competitors with better business models.
Wal-Mart is a Motley Fool Inside Value recommendation. To find more top-shelf stocks unfairly dumped in Wall Street's bargain bin, sign up for a free 30-day guest pass .
Fool contributor Ryan Fuhrmann has no financial interest in any shares mentioned. Feel free to email him with feedback or to discuss the company further.
