It's holiday season again and time to look at some retail stock picks. While the market as a whole is attractively priced, thanks to a drastic downward slide over the past 4+ weeks, the same cannot be said about many key retail stocks. There are a few interesting picks though, including a big contrarian one.
Starting with the contrarian one, let's look at J.C. Penney (JCP). Trading at a bit over $17, the stock is close to its 52 week low, and has crashed more than 60% since CEO Ron Johnson unveiled the company's new transformational strategy in late January 2012. Same store sales have fallen consistently over the past few quarters and revenue would possibly end up slightly higher than $13.0 billion as compared to over $17.0 billion over the past 4 years. 12 out of 19 analysts covering the stock have a strong sell or sell rating, and several analysts have raised worries related to its cash flow position for FY13. So, why is it even worth looking at the stock?
First and foremost, one has to believe in Ron Johnson's transformational story at JCP - and I do. When you make a dramatic switch from a round-the-year coupon and sales driven model to a everyday 'fair and square' price model, same store sales would inevitably tank due to defection of some of the existing customer base. However, if JCP has the money to sustain itself during the transition period and is able to attract (for lack of a better word) a 'better' customer and product mix, the strategy will eventually pay off through higher sales per square feet and better operational margins. For anyone who loathes the dreary, endless rack-after-rack layout of typical big box retailers, JCP's new malls-within-a-mall concept is a welcome change. By decreasing private label assortment to 25% (from 50% earlier), introduction of several new designer labels and by realigning its merchandise layout around key brand 'shops', JCP hopes to attract a higher percentage of upwardly mobile/less price conscious customers who will eventually help drive higher margins. As long as it is able to drive some edgy campaigns and increase recall and visibility among such customer segments, JCP should be able to achieve that. Anyone who questions the viability of such a model should look at how Target (TGT) has performed relative to its competition.
Though several analysts have questioned JCP's cash flow position, the company has a solid current ratio position and enough projected cash flows to sustain its planned expansion of 30+ additional store fronts even if it maintains a revenue of just over $13.5 billion in FY13, with a flat operating margin.
Last but not least, Ron Johnson has got a quality team to back him, and if he is able to repeat at least anything close to what he did at Apple (AAPL) and Target, we have got a significant upside in revenues over the next 12 months. Moreover, management's moves of repaying debt, repurchasing shares and cutting dividends all point to a firm self-belief in the transformational plan. So, as long as you believe in the idea that big-box apparel retailing can be more 'sexier' than a Macy's (M) or a legacy JCP, there is enough room for a strong contrarian move if you have a 12-month horizon. And, the fact that current short interest is already over 30% should give you some cheer indeed.
Other picks in my list for this holiday season are not as flashy or contrarian:
Priced closed to its 52 week low at ~$9 and close to 50% below its 52 week high, Kirkland's (KIRK) is attractively priced at a P/E of around 12. By most valuation metrics, including earnings-based models and book value models, the stock is under-valued. Apart from this, I personally like this pick - with its unique assortment of home decor, the store has a firm positioning within its own loyal customer base due to its merchandise assortment. Overall, it is a pick with limited downside and room for a good upside over the next 6 months - a view that is also supported by a majority of analysts covering this stock.
The next pick, TJX Companies (TJX), is already close to its 52 week high at ~$44 and a P/E of 18.4. However, this is a case of a retailer which has consistently shown increase in total and same store sales (over 7% y-o-y increase in total sales over past 3 years), with extremely strong return on capital metrics pegging it in the top 90+ percentile in the industry. Personally, this is one of my all-time favorites - it has a very powerful assortment of brands (TJ Maxx, Marshalls, HomeGoods) with a very loyal customer base who consistently shop there for 'interesting' designer merchandise at big-box retailer prices. This model pretty much makes its business model recession proof, as can be seen from its performance over the last 3-4 years. At projected revenues and earnings for the next 3-4 quarters, even a flat P/E would yield a price of over $50-55, providing a neat 15-20% upside.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.