If you're like many people with schoolkids, you may have spent part of this past weekend combing department stores and discount retailers for back-to-school deals.

At least that's what companies like

Federated Department Stores

(FD)

are banking on. Back-to-school is the second most important shopping season behind the year-end holidays. Even so, that doesn't necessarily mean that now is the right time to load up on the stock.

Sure, Federated is one of the best-managed department-store retailers out there. Its shares have become cheaper, too. They have lost more than 10% of their value since I last highlighted the company on

June 16, when I advised against buying the stock. Shares are now down nearly 6% for the year, underperforming the 3.5% decline in the

S&P 500

.

Retailers in general, though, and Federated in particular, face some pretty big challenges ahead. Tougher comparisons against a successful retail environment last year is one of them. And while a strong balance sheet, good cash flow and sizable repurchase plan may provide support for the stock, its current valuation is still not that compelling, given the outlook. Federated trades at a P/E ratio of 11.7 times this year's consensus earnings-per-share estimate of $3.80, slightly below its long-term average of 12.5.

A slew of economic statistics reported recently haven't helped the uncertainty. Last Thursday, retail sales (excluding autos) rose 0.7% for July. While that was a big improvement from the 0.5% decline reported for June, it was nowhere near Wall Street's expectation of a 1.1% increase.

This came on the heels of July's disappointing jobs report, where just 32,000 new jobs were created. Between the uninspiring jobs picture and higher oil prices (gasoline prices in many places are up more than 20% year over year), it's no surprise that an early read on early August consumer confidence from the University of Michigan showed a decline to 94 from 96.7 in July.

But there's more to be concerned about. Although personal disposable income is still rising and should improve if the jobs picture brightens, the fiscal and monetary stimulus that boosted consumer spending last year is largely absent in the second half of this year. Higher interest rates have already slowed the torrid pace of mortgage refinancings, and there's no tax relief this year to help either. It was in the third quarter of last year that many households began receiving their $400-per-child tax credit checks.

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.

Odette Galli is a freelance columnist for RealMoney.com. She has been a writer at SmartMoney Magazine and a senior manager at Ark Asset Management, where she co-managed $3 billion in institutional assets. In addition, Galli was a senior vice president at J & W Seligman. At the time of publication, she had no positions in any of the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this commentary represent a recommendation to buy or sell stocks. She welcomes your feedback and invites you to send your comments to

odette.galli@thestreet.com.