Most investors might look into J.C. Penney (JCP) and wonder whether it is undervalued. In fact, investors can reasonably expect that J.C. Penney will require at least a few years to turn its FCF and EPS to positive. I would argue why investors would wait for J.C. Penney . Instead, we can invest in Macy's (M) for the upside potential of 20%+ while collecting the dividend yield at 2.3%
Why does the Macy's opportunity exist today?
Investors stay away from the apparel industry as consumers have been spending larger portion of disposable income on durables. What's more, Macy's missed its EPS of $0.72 below the Street consensus of $0.78. This was the first headline miss since 1Q 2008. Macy's also provided a lower FY 2013 EPS range to $3.8-$3.9 from $3.9-$3.95 here. Nevertheless, management provided comment on August strength in the earning release to relieve some concern about any more bad news for the upcoming quarter. Given that Macy's is trading at attractive valuation with strong management team, it is now the great entry point for investors to accumulate Macy's stock.
Macy's has been trading most of the time above its 50 days Moving Average since the year of 2011. This is a very bullish technical signal.
Fundamental and the M.O.M strategy:
Source: msn.com financial data
Macy's has been capable of achieving 58.15% growth on average for its EPS assuming that FY 2014 EPS is going to be at the mid point of the management range of $3.8-$3.9. This is impressive and shows the capability of its management to implement the M.O.M strategy. The M.O.M strategies, which are My Macy's, Omnichannel and MAGIC selling, can continue to increase market share and enable comps to grow faster than peers. Let me give more details on the M.O.M strategy below:
For the first M, it is My Macy's. Its success is to give customers what they desire by using customer feedback in order to customize stores' assortment.
For the O, it is the Onmichannel. Macy's has been investing heavily into technology to enhance its online, in stores and via mobile sales channel. Now, Macy's can fulfill its online orders across all stores to increase efficiency and help to meet customer demand on a timely manner.
For the second M, it is the MAGIC Selling. Associates and managers have been given strong training to improve their sales skill in order to increase sale.
The followings are some catalysts driving Macy's stock higher:
1. The Finish Line Inc. (FINL) partnership has already shown very positive result for both Macy's and Finish Line Inc. here. As the footwear segment is expected to perform better than apparel, Macy's did make a good strategic move to partner with Finish Line to add strong athletic footwear into its selection.
2. Bloomingdale's, which caters for higher income customers and belongs to Macy's, has been performing well.
3. Investors should start to notice that the crisis in J.C. Penney can potentially benefit Macy's . As J.C. Penney has lost customers and sales, some might have been stolen by Macy's . In addition, Christmas is the most important season for all retailers. With so much turmoil in J.C. Penney , J.C. Penney might not be able to position itself right in terms of inventory and strategy to promote its products for the Christmas season. This might create a great opportunity for Macy's to capture those potential JCP customers and result in a much better 4Q result than expected.
The EV/EBITDA of Macy's is 22,022 / 3730 with the result of 5.9x. What's more, the EV/FCF of Macy's is 22,022 / 1693 with the result of 13x. In my opinion, both valuation methods show that Macy's have room to advance higher.
Conservatively, I can value Macy's for 12x PE since it is expected to have a growth rate above 12% per year for the next 5 years here. With 12x PE and $4.36 EPS in FY 2014, Macy's can achieve a valuation of $52, which is my conservative and highly achievable target price. Together with Macy's 2.3% dividend yield, Macy's is highly probable to generate 20%+ upside for investors within a year.