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3 department stores with the right stuff
With racks full of name-brand merchandise, many of these masters of the malls are fending off the challenge of specialty shops and big discounters. These in particular look like winners.
By Robert Walberg
They may be the dinosaurs of retail, but department store chains are giving no indication that theyre approaching extinction. To the contrary, the groups stocks have enjoyed a tremendous run over the past year, with an average gain of 52%. That compares quite favorably to the S&P 500s ($INX) gain of 38%.
So what have the department store chains done to breathe life back in their businesses, and will they be able to sustain their momentum going forward?
The shirt on your back
One of the challenges facing department stores is the task of keeping their apparel merchandise fresh in a market increasingly dominated by specialty stores. Going back 30 years, consumers preferred to shop in the department stores because they could buy all the items they needed -- clothes, hardware, electronics, and toys -- in one spot. The advent of the mall changed all that, as it brought together a collection of specialty shops in one spot so that shoppers could find most, if not all, of the goods they were looking for in one place, if not one store.
Though the big department stores anchored the malls, they started to lose business to the specialty shops, especially the specialty apparel stores such as Gap (GPS, news, msgs), Abercrombie & Fitch (ANF, news, msgs), Gymboree (GYMB, news, msgs), AnnTaylor Stores (ANN, news, msgs) and The Limited (LTD, news, msgs).
In an attempt to stop the bleeding, if not reverse the trend altogether, department store chains are working hard to offer better quality, more stylish apparel. A perfect example is Sears (S, news, msgs). Its recent acquisition of Lands End and its introduction of a new womens line created by Jones Apparel Group (JNY, news, msgs) place it in much better position to gain share in todays highly competitive market. Meanwhile, Lord & Taylor (a division of May Department Stores (MAY, news, msgs)) and Bloomingdale's (a division of Federated (FD, news, msgs), as is Macy's) are featuring such popular brands as DKNY, Kenneth Cole (KCP, news, msgs), Calvin Klein, Ralph Lauren (RL, news, msgs), Anne Klein, Kate Hill, Joseph Abboud, Armani and Nine West in favor of their old house brands.
On the lower end of the price scale, Kohls (KSS, news, msgs) offers Lee, Levis, Dockers, Haggar (HGGR, news, msgs), Reebok (RBK, news, msgs), OshKosh BGosh (GOSHA, news, msgs) and Columbia (COLM, news, msgs). Not only are the department store chains offering more recognizable and respected brands, they often are doing so at prices more attractive than specialty competitors.
Dueling with discounters
But more engaging apparel offerings dont tell the whole story. Department store chains also are benefiting from the surge in housing activity, as it has increased demand for so-called white goods both big and small. While there are a number of specialty retailers in this area -- most notably Bed Bath & Beyond (BBBY, news, msgs) and Williams-Sonoma (WSM, news, msgs) -- Bloomingdale's, Macys, Sears and J.C. Penney (JCP, news, msgs) offer a wide variety of home accessories from pots and pans to club chairs to full dining room sets. In fact, Federated recently upped its fourth-quarter guidance, in part due to strength in its home-furnishings business.
Of course, if the housing market starts to slow because of higher interest rates, the department store chains could experience a dip in this area, putting future earnings estimates in question later this year. Another threat to the department store group comes from the big discounters such as Wal-Mart Stores (WMT, news, msgs), Target (TGT, news, msgs) and Costco Wholesale (COST, news, msgs). Not only are these stores offering a similarly wide breadth of merchandise, they are doing so at even more attractive price points.
Thus competition from deep-discounters has put increased pressure on the already slim profit margins of department store companies.
To compete against the Targets and Costcos and justify higher prices, the department store chains must offer superior service. Yet with few exceptions, such as Nordstrom (JWN, news, msgs)), this is an area that all the department store chains need to improve on. Consumers wont pay up for service thats no better than a discounter's.
| Retail stocks to watch | | Company | Current price | 12-mo. chg | 52-wk hi/low | Estimated P/E | | The winners | | | | | | Federated (FD, news, msgs) | 49.65 | 107% | 50.60/23.51 | 13.1 | | Kohls (KSS, news, msgs) | 47.48 | -5.0% | 65.44/40.81 | 22.3 | | JC Penney (JCP, news, msgs) | 27.49 | 49% | 28.35/15.57 | 17.8 | | | | | | | | Don't make the cut | | | | | | Sears Roebuck (S, news, msgs) | 45.48 | 63% | 56.06/18.25 | 9.8 | | May (MAY, news, msgs) | 34.12 | 78% | 34.18/17.81 | 16.4 | | Dillard (DDS, news, msgs) | 17.60 | 18% | 18.16/12.32 | 32.0 |
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The three that look best
Though the group still faces a number of challenges, overall they are better positioned to sustain modest earnings growth of 8%-12% today than they have been for the last few years. Those companies that can achieve high single- or low double-digit growth rates will be among the industrys better performers.
The companies most likely to accomplish this objective are Federated, Kohls and J.C. Penney. All three are taking meaningful steps to reduce costs, improve product mix and enhance already comparably strong financials. Of the three, Federated offers the nicest mix of merchandise and price points, while Kohls greater expansion opportunities and higher profit margins suggest that it will continue to post the most impressive long-term growth rates. Over the short term, however, Kohls is more apt to struggle because of tough comparisons and disappointment over slowing sales growth. This value-oriented retailer, the only one of the big department store chains to post a decline over the past 12 months, is now a decent turnaround candidate for patient investors.
Turning to the stores I don't think make the cut, lets start with Sears. While it deserves the nod over J.C. Penney in the area of merchandising mix, the latters financials are stronger and should improve further with the upcoming divestiture of its Eckerds drug store chain. Sears must also prove that its efforts to bolster its apparel business will resonate with shoppers over the long-term. Thus, Sears just misses the cut.
Like Sears, May and Dillards (DDS, news, msgs) were left off my buy list in part because of concerns over their high long-term debt levels and rich valuations.
Consequently, while May and Dillards enjoy some of the more attractive merchandise offerings, on balance the stocks are fairly priced at current levels and will do well merely to keep pace with the broad market. Ill track them all over the next few months and report back.
Editor's Note: At the time of publication, Robert Walberg did not own or control shares in any of the stocks mentioned in this column.
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