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Saks' Price Tag Too High

Bets on the retailer's turnaround have sent the stock to lofty levels.

I love a good turnaround play.

For instance, I'm champing at the bit

waiting for evidence that things are improving at


(GPS) - Get Gap, Inc. (GPS) Report



(WMT) - Get Walmart Inc. Report

is dirt cheap

for a reason, but investors could be rewarded if its enormous house gets in order. And


(MCD) - Get McDonald's Corporation (MCD) Report

has shown remarkable success in shifting its image from an artery-clogging fast-food joint to a healthier restaurant with a great cup of joe in addition to Big Macs.

Now another well-known brand,



, has found its footing. The luxury retailer reported better-than-expected first-quarter numbers Monday, confirming that its improvement is progressing.

But I don't love this turnaround play. The fix is already priced into Saks' stock -- and then some.

Margin Miscues

In the first quarter, Saks earned $11 million, or 7 cents a share, down from $77.9 million, or 57 cents a share, a year earlier, because of the divestiture of its department-store division. Excluding one-time items, Saks earned 19 cents a share in the quarter, topping Wall Street's estimate of 16 cents.

Sales rose 16% to $793 million, beating analysts' average estimate of $787 million. Same-store sales for the quarter jumped a sizzling 14.4%, coming off an easy comparison of a 1.9% decline last year.

However, a 6-basis-point improvement in gross margin to 41.4% was viewed as something of a disappointment. Morgan Stanley's Michelle Clark, for one, expected gross margin to come in at 42.1%.

Saks is clearly in the sweet spot in retail. High-end stores such as Saks and

TheStreet Recommends


(JWN) - Get Nordstrom, Inc. (JWN) Report

continue to perform well, while those catering to a lower-income demographic are seeing performance deteriorate.

So what happens to Saks' margins if the high end gets hit by rising gas prices, weather or a myriad of other factors?

Saks' management said on the company's conference call that an 8% operating margin is attainable "in the next three years or so." For 2007, management projects operating margin of 4%.

It appears that the company doesn't have a cushion in its margins for any kind of adverse event or missed execution. Saks' numbers pale in comparison with those at Nordstrom, whose first-quarter operating margin was over 10%.

Expensive Shopping

According to Thomson Financial, analysts' currently expect Saks to post earnings of 46 cents a share for the fiscal year ending in January. That gives the stock's value a pricey 48 times projected earnings.

Saks' growth rate is projected to be a torrid 19.9%, the highest of any department store operator. However, the stock's valuation on a variety of metrics is significantly higher than its peers.

By my calculations, if Saks is able to achieve Wall Street's growth goals, the stock is fairly valued at the current price of around $22. A company logging 20% growth while its peers report an average of 13.5% deserves a premium.

But the earnings multiple is already more than double that of the group average. That's a pretty big premium.

After all, the growth forecast will come to fruition


Saks hits all of its targets. As outlined above, there is real risk that the numbers come in below what the company and analysts have projected.

Saks is operating in a near-perfect environment right now. High-end retail is hot, the company is seeing growth in all merchandise categories, and shoppers appear excited about the stores again. But if there's any kind of blip, the margins slide and earnings growth could tank.

Keep in mind, the Wall Street estimates mentioned above were made prior to the earnings report. In the next few days we could see numbers come down a bit. It's unlikely they will go higher.

Still, I'm not confident that Saks can match the lofty expectations of Wall Street. If it doesn't, expect the stock to be punished.

I suspect that sometime this year you'll be able to pick up shares in the $17 range. At that point, expectations are likely to be lower, and the chances of an upside surprise will be better than they are now.

At that point, Saks might become a nice turnaround play after all.

In keeping with TSC's editorial policy, Lichtenfeld doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.

Marc Lichtenfeld was previously an analyst at Avalon Research Group and The Weiss Group and a trader at Carlin Equities. He holds NASD 86, 87, 7 and 63 licenses. His prior journalism experience includes being a reporter/anchor for On24 in San Francisco and a managing editor of InvestorsObserver, a personal finance Web site. He is a graduate of the State University of New York at Albany. He appreciates your feedback;

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