Retail Stocks: What to Buy and Why

By Greg Jensen

As consumers, we often fool ourselves. We tell ourselves that we want certain things, but when they are offered we continue to do what we habitually do. Take JC Penney (JCP), for example. At the beginning of 2012, when JCP announced their new strategy, I, and seemingly everybody I spoke to or read, was pleased. Finally a department store was going to simplify things! Instead of marked up prices and endless sales we would get sensible pricing. We were going to be treated like adults! This was what we had been waiting for, and it would surely translate into sales and profits. Not so much. Fourth quarter earnings revealed a 28% year on year decline in sales; just one in a litany of disastrous earnings reports for the once proud retailer. The stock has reflected the performance.

Before you assume this is another “this time it’s the bottom, seriously, buy JCP now!” type of article, let me assure you I see no reason for things to change. If anything, a case could be made that the stock is still overvalued given the size of last year’s losses. It’s just interesting to me that presumably all of those people who said they wanted to be treated like grown-ups continued to be suckered in by “Fantastic savings! This week only!” etc.

So, if buying the ultimate distressed stock in the retail sector isn’t the answer, how are we supposed to respond to this morning’s great retail sales numbers? There are a couple of other department store stocks that I think may have room for improvement in a market that seems to be rapidly approaching, if not overtaking, fair value.

Little Rock, Arkansas based Dillard’s (DDS) still does things the old way, with coupons and sales. They missed earnings when they reported a couple of weeks ago, showing an EPS of $2.87 vs a street average of $2.90, but this could well be as a result of over enthusiastic upward revisions following two 28% beats in a row.

The resulting steep drop off from the $88 level is really just a healthy correction and an opportunity to buy at something other than nosebleed highs. With a P/E of around 12 there is still room for multiple expansion and as the consumer becomes more comfortable, the credit business could boost sales and revenue. A run up to triple digits looks very possible.

The other department store name that I like is Kohl’s (KSS).

Even as EPS estimates have risen, KSS has consistently met or beaten expectations. They have good brand recognition and seem to have a reputation for value. (I have no evidence for this other than anecdotal, but, to me at least, it seems to be widespread.) At a P/E of around 11, there would, once again seem to be room for some expansion. There has been a feeling for a while that consumers would trade up as the economy improves, but I am not so sure. The lessons of 08/09 still loom and value shopping seems to have lost some of its stigma. There is no shame in collecting Kohl’s Bucks.

This idea of the consumer trading up has also resulted in interest in higher end retailers such as Coach (COH) and Michael Kors (KORS). Both names may be interesting for different reasons. COH looks like value while KORS is pursuing aggressive growth, but for now my preference would be for a couple of established names that play the incentive game that we profess to hate, but can’t resist. Silly us!

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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