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Retail Highs and Lows: Undervalued Department Store Stocks with High ROE

Mary-Lynn Cesar, Kapitall: The holidays have passed, but department stores’ sales reports and imminent store closings are inspiring investors.

On Wednesday, Macy’s (M) announced it will combine its Midwest and North regions, restructure positions within stores and districts, and close five stores this spring in an effort to save $100 million annually.

Read more from Kapitall: Income Investing: 9 Dividend Champions With Low Valuations​

The cost-reduction measures were warmly received by investors, with shares rising almost 4% after market close. As a result of the reorganization, roughly 2,500 people will lose their jobs and the retailer will incur $120 million to $135 million in charges during its fourth quarter, which ends on February 1, 2014.

Macy’s also released its results from the holiday season, and sales rose by 3.6% in comparison to last year’s holiday shopping period. In that same statement, Macy’s included its initial guidance for fiscal 2014. The retailer projects a 2.5-3% increase in comparable sales in FY2014 over FY2013 and expects earnings per share to fall between $4.40 and $4.50.

Click on the interactive chart below to see stock price data over time.

Retail winter blues

The retail climate and stock market have been considerably less forgiving to department store chain J.C. Penney Co. (JCP). J.C. Penney has been fighting an uphill battle since posting a 25% decline in annual sales under former CEO Ron Johnson, who was fired last April.

As of September, Bloomberg reports, the company released monthly same-stores sales as proof of its recovery in the time following Johnson’s departure. Nevertheless, in November, the company was kicked out of the S&P 500 after its market value declined by 37% to $2.7 billion over the course of the year. S&P stated that J.C. Penney’s market capitalization was “now more representative of the mid cap market.”

Click on the interactive chart below to see stock price data over time.

J.C. Penney’s three-sentence holiday sales statement, released on Wednesday, expressed satisfaction with the company’s performance but lacked any figures or details. Shares fell 10% by closing bell on Wednesday in the wake of the department store chain’s comment.

Wednesday also saw an order from the US Bankruptcy Court in Manhattan authorizing liquidators to conduct “Going Out of Business” sales at discount retailer Loehmann’s stores. The 93-year old company filed for its third bankruptcy last month, citing worsening economic conditions in key markets and increasing competition from fellow off-price and outlet retailers and e-commerce companies. Loehmann’s will close its 39 locations in March.

Investing ideas

All of this activity within the department store industry, including soon to be released fourth quarter earnings, inspired us to take a closer look at department store stocks. To begin, we constructed a universe comprised of department stores based in the US. We subsequently narrowed down that group by screening for stocks that have outperformed over the last quarter, with at least a 15% return.

We then looked for potentially undervalued stocks as indicated by a low price to sales (P/S) ratio. A P/S ratio is a valuation metric that compares a stock’s price to what the company generates in revenue. When a company has a low P/S ratio, it means that its price is cheap in relation to the company’s revenue. If a stock’s P/S is below 1, it can be considered undervalued. However, investors should note that this ratio doesn’t take expenses or debt into consideration, and variation between industries is normal.

For this list we screened for stocks with P/S ratios under 2, which means that the company’s market cap isn’t greater than 2x its annual sales.

We added one final metric to help us isolate stocks with encouraging signs of profitability. We screened the remaining group of stocks for those possessing a return on equity (ROE) greater than the industry average. ROE measures a firm's profitability by expressing a company's profits as a percentage of shareholder equity.

We were left with four department store stocks on our list.

Click on the interactive chart below to see sales data over time.

Do you think these department stocks will perform well in 2014 ? Use this list as a starting point for your own analysis.

1. Bon-Ton Stores Inc. ( BONT): Operates department stores in the mid-size and metropolitan markets of the United States.

Market cap at $301.09M, most recent closing price at $15.68.

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