Department Store Stocks Attracting Window Shoppers

by: Justin Kuepper

Department stores shouldn't be a screaming buy with anemic consumer spending and a questionable recovery in employment. In January, U.S. consumer spending rose just 0.2%, below analysts' expectations. Meanwhile, economists like those at ShadowStats suggest that the real unemployment rate may be closer to 20% when counting "discouraged workers."

However, retail investors don't seem to be noticing those data points, with the sector jumping 13.5% over the past month, according to Tickerspy's index. In this article, we'll take a look at the reasons for this trend and whether it's likely to be sustainable.

The companies included in Tickerspy's index are:

  1. Macy's Inc. (NYSE:M)
  2. Dillards Inc. (NYSE:DDS)
  3. Nordstrom Inc. (NYSE:JWN)
  4. J.C. Penny Company Inc. (NYSE:JCP)
  5. Gordman Stores Inc. (NASDAQ:GMAN)
  6. Saks Inc. (NYSE:SKS)
  7. Sears Holdings Corporation (NASDAQ:SHLD)
  8. Kohl's Corporation (NYSE:KSS)
  9. The TJX Companies Inc. (NYSE:TJX)
  10. The Bon-Ton Stores Inc. (NASDAQ:BONT)

A look at two of the top performers

Bon-Ton Stores and Sears are two of the sector's top performers over the past month, rising 66.5% and 60.4%, respectively.

Earlier this month, Bon-Ton Stores reported fourth-quarter earnings of $3.07 per share, versus a consensus of $3.19 per share, on revenues of $983.2 million, versus a consensus of $1 billion, as same-store sales dropped 2.6%. While these were disappointing results, shares rallied more than 30% on that day when the company issued sharply higher-than-expected FY2012 forecasts.

For the full-year 2012, the company expects to earn between 15 cents and 75 cents, compared to a $1.26 consensus loss, with same-store sales up between 1% and 2%. Much of this growth will be driven by growing e-commerce sales, its private label credit card business, and more attention to small stores in niche markets, all rather than expanding the firm's traditional business.

Sears has a very similar story. Last quarter, the company reported earnings of 54 cents, compared to 78-cent estimates, on revenues of $12.5 billion, versus a $12.44 billion consensus, as same-store sales fell. But again, it was the store guidance and future plans that drove the stock price higher, despite the lackluster financial results.

The company plans to spin off 1,250 stores and sell 11 others for $270 million, cut its inventory by $580 million, and evaluate other opportunities to separate parts of its portfolio into separately owned companies. These efforts, led by its activist Chairman Edward Lampert, are designed to boost the company and build value for shareholders.

Return to fair value or irrational exuberance?

The department store sector has rallied over the past month, but many of these gains appear to come from companies like Bon-Ton Stores and Sears. These two companies have rallied due to a brighter future outlook rather than the current market situation. And both of these outlooks are due to internal changes rather than a change in external consumer behavior.

However, other department store retailers are also showing signs of a slower turnaround. Many investors believe that this may be due to a brighter macro outlook at their low valuations. Even after their collective rise, the sector trades with an average price-earnings ratio of 19.2x, according to Tickerspy, which is still less than the S&P 500's 22.77x multiple.

As for the macro outlook, the data remains pretty mixed. Consumer confidence has been on the rise, reaching -36.7 for the period ended March 4, which is the highest since April of 2008. However, the Consumer Reports Index fell this month, highlighting troubles especially in households earning $50,000 or less.

In the end, much of the gains seen in the department store sector have been realized due to a combination of internal changes and optimism looking forward. Whether that materializes remains to be seen, and P/E multiples remain reasonable, but investors should still exercise caution, perhaps with a covered call strategy or protective puts.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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