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May 10, 2016

Department Stores Face Rising Competition

by Jharonne Martis.

They were once rulers of the retail kingdom, but these days department store chains are closing stores, spinning off real estate and cutting jobs. The big players will be reporting earnings in the next couple of weeks, with the first one scheduled to report being Macy’s (M.N) on May 11. Revenue and earnings growth for Q1 are expected to decline by -4.6% and -42.9%, respectively.

We can expect to hear these reasons for Q1 weakness: the strong dollar is affecting earnings and tourist traffic at home. Other negative factors expected to be cited: a weak retail environment, online competition and market store saturation for big box retailers. Macy’s talked about the importance of investing in omni-channel strategies, which keep evolving because “the customer today wants personalization, not necessarily in store but online” (Source: Karen Hoguet, CFO, Macy’s, Inc., 4/27/16, StreetEvents).

Bearish analyst reports

According to StarMine, this might not be the end of the bad news. The bulk of the department stores score in the bottom tertile on the Analyst Revisions Model (ARM), which means analysts polled by Thomson Reuters are bearish on these retailers, and are lowering their earnings estimates for the quarter – with the exception of JC Penney (JCP.N) and Bon Ton.  JC Penney has stepped up its merchandise offering, helping the company regain its core shopper, while lowering SG&A expenses. In its last earnings call, JC Penney said it’s benefiting from its home, Sephora, and footwear segments. The retailer plans to open 60 more stores-within-a-store in 2016.

Exhibit 1: StarMine Analysts Revisions Model (ARM) Scores

dept1

Source: Eikon

Comeback from near-death

 Although JC Penney has risen anew, analysts have become bearish on the retailer since last week. StarMine data suggest that JC Penney is on track to post a negative earnings surprise for the first quarter of 2016, with the StarMine Smart Estimate falling below the consensus earnings forecast and creating a Predicted Surprise of -11%. This suggests that the company is very likely to miss earnings estimates.

Stocks trend lower

The bulk of these retailers score a 17, or lower, on the Price Momentum Model (PriceMo) suggesting price stock momentum is very negative, and the stock price is likely to continue to decline.

Exhibit 2: StarMine Price Momentum Model (PriceMo) Scores

dept2

Source: Eikon

Cheap for a reason

What’s more, these department stores stock prices appear cheap on a relative value basis, where almost all of them score in the top quartile of the StarMine Relative Valuation model (Exhibit 3).

Macy’s is in the top percentile of both the StarMine Intrinsic and Relative valuation models, suggesting that its stock looks cheap. It is currently trading at $37.65, with a negative market implied growth rate of -0.6%. However, StarMine’s Intrinsic Valuation model thinks it should be trading closer to $74.74. But watch out, the stock may be cheap for a reason.

Exhibit 3: StarMine Relative Valuation (RV) Scores

dept3

Source: Eikon

Spring slowdown

In general, mall traffic slows down after the holidays, going into spring. However, department store traffic was weaker than usual during this first quarter. As a result, earnings, revenue growth rates and Same Store Sales are expected to be negative for the quarter.

Exhibit 4: Dept Store EPS, Revenue Growth Rates % and SSS Estimates for Q1

dept4

Source: I/B/E/S data

Credit worries

To determine which department stores may be in danger of default in 2016, we looked at our StarMine Combined Credit Risk model, the most comprehensive StarMine credit model. Several department stores, including JC Penney and Sears (SHLD.O), had been in the riskiest quartile of all retailers likely to default in the United States for some time now. Macy’s just recently joined this list of weak performers, with a score of 25. Seven out of nine stores rank in the bottom of the StarMine Combined Credit Risk (CCR) model score. These scores correspond to implied credit ratings of BB+ or worse, suggesting these stores are not financially stable.  For example, Macy’s has a score of 25 corresponding to a BB+ implied credit rating, according to the StarMine Combined Credit Risk Model.

Exhibit 5: StarMine Combined Credit Risk Model Scores – Department Stores

dept5

Source: Eikon

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