8/11/2011
By Brian Sozzi, Research Analyst

Who said department stores were boring (aka relics of yesteryear) places to consume non-essentials and as an analyst, dissect quarterly earnings reports?   Certainly not this childhood Sears shopper and now resident stock market handicapper!  In the matter of two days we have received two earnings reports from the leading department stores, Macy's (M) and Kohl's (KSS), which defy the conventional wisdom held on numerous fronts:

1. Consumer spending by middle-income to upper middle-income households is as dry as the Sahara.
2. Ticket price increases, borne from the inflationary scare in the first half of the year, would crush consumer demand.

Selectivity is key when picking retail stocks in the current volatile environment.  For as solid as the earnings reports were from Macy's and Kohl's, when I hear Family Dollar (FDO) blame the paycheck cycle for its poor sales (likely to hear this from Wal-Mart next week also) and see units per transaction weaken at specialty apparel retailers clearly all is not completely fine and dandy for many households across the country.  That being said, there are some things going on here with respect to second quarter retail earnings overall.  Getting granular...

* Management teams sparked hysteria on the margin outlook on their 1Q11 earnings calls.  Can't blame them, visibility on costs was minimal, but it looks like they assumed disaster scenarios...and the analysts bought it hook, line, and sinker.
* Management teams low-balled the Street on: (1) when price increases were taken in the year; and (2) within how many product classifications they were taken.
* The importance of technology advances to planning and allocation should not be discounted; businesses are simply planning their businesses tighter, say by offering localized promotions, online only promotions, and localized inventory.
* Online shopping shift continues, and consumers are finding exciting, higher-priced exclusives that pries the plastic from their wallets.

Shares of Macy's and Kohl's trade on roughly equivalent forward P/E multiples; 8.4x for Macy's and 8.7x for Kohl's.  I continue to think if one is inclined to jump into consumer discretionary currently, the stock of the targeted company must be deeply discounted and have a strong investment thesis.  Macy's fits the bill better than Kohl's.  Macy's is managing its inventory in a stronger manner than Kohl's, is aggressively paying down debt, and continues to raise its fiscal year guidance due to momentum behind fundamental drivers, instead of share repurchases as is the case at Kohl's.

Tale of the 2Q Tape: Macy's vs. Kohl's

Same-store sales:
* Macy's: +6.4%
* Kohl's: +1.9%

Gross margin:
* Macy's: 41.80%, down 10 bps y/y; beat consensus by 6 bps
* Kohl's: 40.67%, up 41 bps y/y; fell short of the 41.00% consensus

Inventory:
* Macy's: Inventory growth of 6.8% y/y, below the pace of sales growth of 7.3%
* Kohl's: Inventory growth of 5.6% y/y, above the pace of sales growth of 3.6%

Guidance:
* Both companies raised their fiscal year guidance.  Have to highlight Macy's, as it raised its range to $2.60-$2.65 p/s, approximately $0.35 p/s more on the low-end from the range issued earlier in the year

Brian Sozzi
Wall Street Strategies

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