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Saks Inc (NYSE:SKS) has been in the news lately with unconfirmed news reports in the Wall Street Journal revealing that the company had hired Goldman Sachs (NYSE:GS) in order to assist in exploring strategic options. Hudson's Bay, a Canadian department store retailer has emerged as one of the possible suitors. A deal is however not imminent according to recent reports owing to the rich valuation of the stock. In this article, I will perform a fundamentals based analysis of the stock and determine the fair valuation along with that of its peer group. The peer group selected for analysis includes Macy's (NYSE:M), Nordstrom (NYSE:JWN) and Dillards (NYSE:DDS).

The table that follows presents the basic information of these companies.

Company Basics

SKS

JWN

DDS

M

Market Cap (Billion)

2.03

11.2

3.71

17.7

Debt to Capitalization Ratio

16%

28%

22%

39%

Stock Performance 5 Yr

-13%

8%

102%

6%

Stock Performance 1 Yr

35%

17%

23%

37%

Dividend Yield

0.0%

2.1%

0.3%

2.2%

SKS is by far the smallest company in the group with a market capitalization of approximately $2 billion while M is the relative giant with a market capitalization of about $18 billion. SKS does not pay a dividend at this point of time. JWN and M have a very similar dividend yield in the neighbourhood of 2.1%. One major positive for SKS is its relatively low debt to equity ratio. M carries a comparatively higher debt load while JWN and DDS have a debt to market capitalization in the 20 to 30% range. Over the past year, all the 4 companies have increased handsomely in price with SKS and M leading the way. However, during the past 5 year period, SKS was the only company on the list that saw its stock decline in value.

Growth Rates:

Next, I evaluated the historical growth rates of revenue, income, EPS, book value and the projected growth rates. These are summarized in the table shown below:

Growth Rates

SKS

JWN

DDS

M

Revenue

10 Year

-6%

6%

-1%

6%

5 Year

-1%

7%

-2%

1%

1 Year

4%

12%

5%

5%

Income

10 Year

-3%

12%

44%

7%

5 Year

6%

1%

44%

8%

1 Year

-16%

8%

-28%

6%

EPS

10 Year

-3%

15%

51%

6%

5 Year

6%

4%

59%

10%

1 Year

-9%

13%

-19%

11%

Book Value

10 Year

2%

-3%

-5%

1%

5 Year

2%

-4%

-9%

-2%

1 Year

-13%

-5%

-9%

-3%

Growth Projections

Next Year

29%

12%

8%

13%

Next 5 Year

14%

12%

6%

14%

SKS has struggled over the past decade with revenues declining at an annual rate of 6%. Although revenue was up 4% last year, EPS declined by 9% and the book value also fell by 13%. Among the peer group selected, JWN and M have performed fairly well during this time period. Looking ahead, SKS is expected to increase its earnings by 29% next year and at an annual rate of 14% over the long term. This projected growth rate is the highest among the peer group and matches that of Macy's.

Margins

After analyzing the growth rates, the next step was the evaluation of gross and operating margins of the 5 firms. The results are presented in the table below.

Margins

Averages

SKS

JWN

DDS

M

Gross Margins

10 Year

38%

38%

35%

40%

5 Year

38%

38%

35%

40%

Last Year

41%

39%

37%

40%

TTM

41%

39%

37%

40%

Operating Margins

10 Year

2%

10%

3%

6%

5 Year

1%

11%

4%

3%

Last Year

4%

11%

8%

10%

TTM

4%

11%

9%

10%

SKS and its peers have done a remarkable job of maintaining their gross margins. SKS average gross margins over the past decade were 38% which have now expanded to 41%. A similar trend was also seen in the case of DDS. The operating margins of SKS also expanded during the past decade. However, the margins greatly trail the peer group selected with the 3 peer companies reporting margins in the 9% to 11% range compared to the 4% operating margins reported by SKS last year.

Profitability:

To evaluate the profitability of the SKS and its peers, ROIC and ROA were selected as the desired metrics. Again, SKS is a laggard by these metrics with poor ROIC and ROA ratios. JWN and DDS are closely spaced by ROIC measure while SKS has struggled providing a return on invested capital of a measly 2%. A similar trend can also be seen in the ROA metrics.

Operations

Averages

SKS

JWN

DDS

M

ROIC

10 Year

-1%

13%

2%

1%

5 Year

-2%

11%

4%

-3%

Last Year

3%

12%

10%

8%

TTM

2%

12%

11%

9%

ROA

10 Year

1%

9%

3%

2%

5 Year

0%

8%

4%

0%

Last Year

3%

9%

8%

6%

TTM

2%

9%

8%

6%

Valuation:

Having developed a good idea about the fundamentals of the SKS and its peers, the next step was to perform relative valuation. The multiples used in the analysis were based on historical analysis of individual companies and industry multiples. The table below presents the valuation analysis results.

Valuation

SKS

JWN

DDS

M

Next Yr Est

$0.53

$4.24

$8.07

$4.47

EPS Growth Rate

14%

12%

6%

14%

Future EPS (5 Yr)

$0.84

$6.05

$10.00

$7.15

Expected P/E

12

15

13

14

Price 5 Yrs Out

$10.12

$90.81

$129.97

$100.15

Unlevered Beta

1.14

1.14

1.14

1.14

D/E Ratio

16%

28%

22%

39%

Current Tax Rate

35%

35%

35%

35%

Levered Beta

1.26

1.35

1.30

1.43

Risk Free Rate

2%

2%

2%

2%

Risk Premium

6.00%

6.00%

6.00%

6.00%

Size Premium

1.54%

0.62%

0.97%

0.62%

Cost of Equity

11.1%

10.7%

10.8%

11.2%

Fair Value

$5.99

$54.62

$77.84

$58.91

Current Price

$13.69

$59.06

$81.74

$47.48

% Overvalued

56%

8%

5%

-24%

As shown in the table above, SKS is significantly overvalued at current levels and is a short candidate in my opinion. The rumors of acquisition by another firm will likely provide a floor for the stock. M is the only undervalued company in the peer group and is a Buy candidate in my opinion. JWN and DDS are both slightly overvalued and should be avoided at current levels.

(Kindly use this article for information purposes only. Please consult your investment advisor before making any investment decision.)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Saks Is Overvalued By 56%