Federated Discount Not Large Enough

Comparisons also get tougher for Federated. The company's comparable-store sales rose 3.2% last September and averaged a positive 0.3% for the third quarter of 2003 as a whole. That was the first time Federated had posted positive same-store sales in 12 quarters. After posting comparable-store sales growth of 3.3% in the just-reported second quarter (which went up against a decline of 1.2% last year), Federated has a little less sanguine outlook for the remainder of this year, given the tougher comparisons. It sees same-store sales growth in a range of 1.5% to 3%.

The company could also face challenges on the margin front for the rest of this year. Thanks to tight inventory controls (inventories were down 2.4% compared with a sales increase of 3.3% in the second quarter) and lower markdowns, Federated's gross margin in the second quarter rose 30 basis points to 41.4%, excluding charges related to store closings and its Macy's Home Store centralization initiative that should be completed this year.

But sales, general and administrative expenses rose much faster than sales, or 6%, to account for 34.2% of sales compared with 33.3% last year. Some of this had to do with store-closing and centralization issues that could go away next year, but not all of it. As a result, Federated's operating profit margin fell to a disappointing level of 6.9% from 7.7% last year.

Even so, investors can take much comfort in Federated's improved balance sheet. The company took a 20-cent hit to second-quarter earnings to retire $273 million in long-term debt bearing 8.5%. This will reduce quarterly interest expense by almost $5 million, or about 2 cents per share after tax. The company ended the quarter with a long-term debt-to-capital ratio of just 34.8%, down from 36.9% last year.

In addition, in late July Federated announced a whopping $750 million increase in its share repurchase authorization (bringing the total to about $1 billion), and said it expected to spend $700 million to $900 million of it this year alone. Through the second quarter, Federated had spent just $351 million. This announcement also served to dispel fears that Federated was eyeing a large acquisition.

There's certainly plenty to applaud with Federated. And although the valuation has gotten modestly more interesting, it's hard to find a compelling reason to jump on the shares right now, given the more challenging retail environment.