Struggling with underperformance, J.C. Penney (JCP) recently announced shocking changes to its brand. Everything from pricing to store layout and logo will be be redesigned. Since the new CEO took over in November, the stock has gone up 6.9% as market confidence is renewed. Based on my multiples analysis and DCF model, I find that Macy's (M) is meaningfully more undervalued from a value standpoint.
Click here for the Street ratings of apparel retailers.
From a multiples perspective, Macy's is the cheaper of the two. It trades at a respective 12.6x and 10.6x past and froward earnings while JCPenney trades at a respective 45.1x and 20.6x past and forward earnings. Both offer dividend yield of 2.3% and are considerably more volatile than the broader market. Gross margins are 150 bps higher at Macy's at 40.7% and are likely to widened given different marketing approaches going forward. Kohl's (KSS), which is rated a "buy" on the Street, is cheaper than all of them at a respective 11.3x and 9.7x past and forward earnings. Macy's nevertheless is the most preferred with its "strong buy" rating. Interestingly, significant downward revisions to EPS have been made for Kohl's and J.C. Penney while overall upward revisions have been made for Macy's.
At the third quarter earnings call, J.C. Penney's Chairman, Mike Ullman, noted challenges and a focus on brands:
It continues to be a difficult consumer environment and this was evident in mall traffic during the period, which was down 2.4% and ultimately in our sales performance. While our higher income customers responded very well to our attractions, our moderate income customers delayed their purchases of fall winter merchandize, as they continued to shop closer to need. That said, while it's little too early to call a trend, we have recently seen stronger sales of cold weather apparel and accessories as temperatures across the country became more seasonable.
There were some bright spots during the quarter that are worth noting. The Liz Claiborne brand remains a standout performer, Sephora is generating strong sales in every location up double digits for the quarter and year-to-date, and the work we have been doing to build our center core businesses is resonating evident in the solid performance level in the accessories businesses.
The marketing revival, which will be launched at the start of February, will emphasize a new pricing strategy, called Fair and Square. This strategy offers three different methods: (1) every day low prices for regulars, (2) monthly deals on certain merchandise, (3) and best prices on the the 1st and 3rd Fridays of each month. The company will also eliminate gimmicky campaigns and instead host promotions monthly, 12 times a year. Stores will feature a "Main Street" theme with 80 - 100 brand shops that are designed to make shopping more convenient and a "Town Square" theme where services will be offered. Continued investments in Martha Stewart, Liz Claiborne, IZOD, and l'amour nanette lepore, among others will continue to drive demand and customer loyalty. Management is further cutting prices by 40% and is likely to focus more on upscale merchandise.
Consensus estimates for J.C. Penney's EPS forecast that it will decline by 21.4% to $1.25 in 2012 and then grow by 32.8% and 32.5% in the following two years. Of the last 18 revisions to EPS, 17 have gone down for a net change of -22.4%. Modeling a CAGR of 11.4% for EPS over the next three years and then discounting backwards by a WACC of 9% yields a fair value figure of $27.98, implying 18.4% downside.
Macy's, on the other hand, has meaningful upside. It produced strong third-quarter results with operating income up 64% and margins expanded by 13.3%. In addition. December same-store sales growth of 6.2% was wlll ahead of consensus. The company has been able to raise prices with minimal effect on volumes - a testament to the appeal of its brands.
Consensus estimates for Macy's EPS forecast that it will grow by 33.5% to $2.79 in 2012 and then by 15.8% and 13.6% more in the following two years. Assuming a multiple of 13.5x and a conservative 2013 EPS of $3.17, the rough intrinsic value of the stock is $42.80, implying 25.2% upside. Modeling a CAGR of 20.6% for EPS over the next three years and then discounting backwards by a WACC of 9% yields an even higher figure of $46.06.