April 21, 2005
Editor: Ian Madsen, MBA, CFA
Tel : 1-800-767-3771, x 417
www.zackspro.com 155 North Wacker Drive l Chicago, IL 60606
Saks Inc. (SKS – NYSE) $17.86
Notes to readers: All new comments since last report are highlighted.
Overview
Saks Incorporated (SKS) is a retailer operating through two business segments: Saks Department Store Group (SDSG) and Saks Fifth Avenue Enterprises (SFAE). SDSG consists of stores operated under the nameplates: Proffitt's, McRae's, Younkers, Parisian, Herberger's, Carson Pirie Scott (Carson's), Bergner's and Boston Store, and Club Libby Lu specialty stores. SFAE includes Saks Fifth Avenue (SFA) luxury department stores and Off 5th Saks Fifth Avenue Outlets (Off 5th).
Saks fundamental outlook remains cloudy, and the analysts believe that valuation downside is likely from current levels. Much of the turnaround story, in their opinion is speculation and they believe that the asset story will support the stock in the near-term, but that the likelihood of a sale or asset monetization is minimal. In 2004, SKS was down (3.8)%, underperforming the department store groups’ equal weighted performance of +23% and the S&P 500 Index performance of +9%. The stock’s weak price performance was attributed to same-store sales volatility and underperformance versus 12 other department stores. Saks Fifth Avenue Enterprises (SFAE) has embarked upon a number of strategic initiatives including the rationalization of its real estate portfolio, upgrading its merchandise assortment, and improving the in-store experience for its customers. However, amidst difficult high-end department store competition and a significant amount of management turnover, SFAE has been unable to significantly improve its operating performance to date. Saks Department Store Group (SDSG) has also been focused on improving its performance through strategic initiatives such as improving the in-store environment, increasing differentiation of its stores and merchandise, and upgrading the in-store product environment to cater to specific demographic categories. Despite the aforementioned efforts, SDSG has continued to struggle from lack of differentiation versus its moderate department store competition as well as from its rapid poorly received rollout of numerous private brands. This good news/bad news situation is evident in the dispersion of analyst opinions: 11% positive, 56% neutral, and 33% negative.
Key Positive Arguments / Key Negative Arguments· The SFAE showed substantial increase in sales.
· Analysts believe that there is upside to SFA’s margins.
· The company has compelling growth prospects.
· Saks has a clean balance sheet with a 40% debt-to-total capitalization ratio. / · Sales performance had been disappointing compared to its luxury peers.
· Margins remain under pressure.
· Merchandising issues at SDSG are still a key concern.
· During the past five years, revenues have grown at a compound annual rate of just 1%, which placed Saks near the bottom of the industry.
· In the past few years, customers have shifted away from shopping malls to the discounters and value-oriented retailers.
SKS’ fiscal year ends January; all calendar references are to the fiscal year.
Sales
Analysts (A.G. Edwards, Banc of America, Lehman, Merrill, Morgan Stanley, and UBS) are forecasting Saks’ consolidated sales to increase 1.2% in 2005 and 2.1% in 2006.
Fourth quarter summary: SKS reported fourth quarter sales which increased 4.9% to $2.07 billion driven by a 4% total comp increase below the 5.9% gain last year, but above the third quarter increase of 0.3%. SFAE sales in the quarter increased 9.8% to $839.9 million driven by an 8.4% comp increase. SFAE continues to intensify core vendors in key items and classifications and introduces more unique products and designers to drive full price sell through. SFAE continues to develop its customer relationship management capabilities, and total spending by top-tier customers (diamonds and platinum levels) was up more than 23% during the year. In 2004, sales from the Saks Fifth direct business (online and catalogs) increased approximately 25%, as SFAE remained focused on growing this piece of the business.
Analysts are of the opinion that Federated’s acquisition of the MAY Department Stores Co. will have a mixed impact on Saks’ consolidated business. The SFAE segment should feel limited impact from the consolidation on a strategic market share level (given its up market niche) and from a real estate perspective. On the other hand, SDSG currently co-anchors 12 malls with Federated and 28 with May. Mgmt believes SDSG should be able to garner additional share from May units as the company transforms itself into Federated’s fold over the next 12-18 months. While this may be true, the analysts question the longevity of this strategy as the May locations post acquisition will eventually incorporate FD’s best practices (merchandise, planning/allocation), which will intensify competitive pressure on SKS.
For the first quarter, one analyst (Lehman) has forecasted a flat comp increase at SDSG. Their forecast is approximately in line with management’s first quarter plan because, although they did not give first quarter comp guidance, full year guidance was for a low single digit increase and management recognized that the toughest comparison was the first quarter. They are forecasting a 3% comp increase at SFAE, also below management’s full year guidance (up mid single digit), but again against the toughest comparison of the year.
See the SKS consensus earnings model for more detail on the analysts’ sales estimates.
Margins
Analysts (A.G. Edwards, Banc of America, Lehman, Merrill, Morgan Stanley, and UBS) expect Saks’ profit margins to improve in 2005 and 2006.
Adjusting for the impact of store closures, consolidated gross margin declined 82 basis points (119 basis points unadjusted), after five consecutive quarters of improvement. The decline was driven by deterioration at both the Department Store Group (SDSG) and Saks Fifth Avenue (SFAE), both of which had higher than planned markdowns. Private label contribution to gross margin was better than in the fourth quarter last year and also improved over the previous two quarters, but was still below consensus expectations.
SFAE’s operating income fell 9.8% to $63.4 million for an operating margin of 5.2% versus 5.8% in 4Q03. Improved gross margin performance driven by a systematic reduction in the level of promotional activity was offset by disappointing inventory management. SG&A expenses increased during the quarter and the year, primarily related to continued investment in key strategic store and marketing initiatives, including an increased number of sales associates and related compensation. Going forward, management believes that a mid single-digit comp will enable SFAE to leverage expenses.
Mgmt believes that SFAE's operating margin can be pushed to a level closer to its peers (NMG) through further asset rationalization (787k sq ft to be closed in F05) and sales productivity enhancements (associate training/accelerating inventory turns). Improvement at SDSG remains more of a cost issue as the segment remains 'very profitable' on a four-wall basis, but maintains an overly burdensome system of corporate overhead. Mgmt insists that reducing this 'overhead' will be a major source of future margin gain and that it will be a focus issue in future business planning. Guidance calls for consolidated EBIT margin expansion of +200-300bps over the next 4 yrs from these initiatives.
Analysts believe that EBIT margin at SFAE should improve steadily during 2005 with the smallest increase coming against tough comparisons in 1Q05. They believe that the division should be able to leverage its operating expense investments made in 2004 of low-mid single digit comp store sales.
One analyst (Smith Barney) forecasted consolidated gross margin to be flat in the first quarter, against the very difficult gross margin increase of 123 bps during last year’s first quarter. Their forecast is below management’s full year forecast of modest gross margin improvement, but again, against the most difficult quarter of the year.
One analyst (Lehman) believes that going forward, gross margin will improve as the company shifts the focus of its SDSG private label strategy. In addition, they believe that the company will achieve additional expense leverage in 2005, as it anniversaries higher SFAE expenses related to key strategic store and marketing initiatives.
One analyst (A.G.Edwards) estimates a flat gross margin for this year.
See the SKS consensus earnings model for more detail on the analysts’ profit margin estimates.
Earnings per Share
The Digest EPS average for FY05 is $0.71.
SKS reported 4Q04 EPS of $0.67 versus $0.69 last year. 4Q04 EPS results fell below the expectations of many analysts driven by gross margin deterioration due to higher than expected markdown and promotional activity at SFAE and erratic sales trends at SDSG.
One analyst (FTN Midwest) has lowered their 2005 EPS estimates based on higher anticipated tax rate and a higher amount of depreciation and amortization related to capital expenditure.
One analyst (Prudential) lowers 2005 EPS estimate from $0.75 to $0.73 to reflect weaker than expected same-store sales in March in SFAE and anticipated weaker margin results in the quarter.
See the EPS and Recent Revisions tabs in the SKS consensus earnings model for more detail.
Target Price / Valuation
The target price for Saks Inc ranges from $10 (Deutsche Bank) to $22 (Lehman). The analyst with the lowest target price (Deutsche Bank) has valued it by applying a P/E multiple 25x2005 EPS estimate, while the analyst (Lehman) with the highest target price has valued it by applying a P/E multiple of 21.2x 2006 EPS estimate. Most of the analysts use a P/E multiple for valuation purpose with multiples ranging from 14x – 25x. The average target price is $15.16.
Go to the valuation tab of the SKS earnings model spreadsheet for more detail on the brokers’ valuation methodologies and individual price targets.
Long-Term Growth
Saks’ long-term growth is a function of the department store industry’s growth prospects, and department stores are facing significant long-term challenges. According to the brokers following Saks, there are two primary issues facing the department store industry. One is the consumer shifting away from mall-based department stores toward discounters and value-oriented, mass-market retailers. The second is fierce price competition that is preventing department stores from raising prices on its apparel.
In recent years, consumers have shifted away from department stores in shopping malls to mass-market retailers such as Wal-Mart and Target. These stores offer customers the convenience of having all types of merchandise under one roof at low prices. As more people walk through the doors at Wal-Mart and Target, there are fewer people patronizing shopping malls. This declining foot traffic is at the root of department stores losing market share. Analysts expect consumers to continue frequenting the discounters at the expense of department stores into the foreseeable future.
What’s more, the discounters and mass-market retailers are also forcing department stores to lower their prices in order to compete. This price competition is pressuring department stores’ sales growth and profit margins. This problem runs deeper than just lower prices. It was only a few years ago that there was a discernable difference in the quality at a Kohl’s vs. a Bergner’s, but that is not the case today. The higher quality merchandise sold by the discounters is more appealing to the value-oriented consumer.
With the help of Accenture, Saks is pursuing supply chain initiatives at SDSG, aimed at enhancing the productivity of inventory systems and processes. “While we believe this could take some time to execute and adopt, we think productivity is likely to improve.” ((Morgan Stanley)
Additional Discussion
Saks has been considering the option of spinning off one segment to create two distinct entities; or selling one or both divisions to a strategic or financial buyer. In the opinion of the analysts, the SFAE division is particularly attractive given the strong luxury market trends and the opportunity to improve its performance to a level in line with its peers. However, they do not believe that SDSG would be as attractive to a strategic buyer, mainly because many of SDSG’s markets are small and would have difficulty meeting a larger department store’s return requirement.
Saks Inc. is making plans to sell its midprice chains in two geographic clusters, according to a published report -- a move that could pave the way for a sale of its remaining Saks Fifth Avenue luxury division. As reported by the Wall Street journal, the department store operator's strategy is to divide the midprice stores into northern and southern group. The northern stores, which are already managed together, include the Carson Pirie Scott, Bergner's, Boston Store, Younkers and Herberger's chains, while the southern stores, also managed together, include the McRae's and Proffitt's chains. The newspaper said the company's Parisian chain, managed separately, might not be included in the sale of the southern division.
Meanwhile, industry trade newspaper Women's Wear Daily reported, that luxury retailer Neiman Marcus Group, which announced last month that it is considering selling the company, has boiled down its list of its top bidders to several private equity groups: Kohlberg, Kravis Roberts & Co., teaming up with Bain Capital Partners, and Thomas H. Lee with The Blackstone Group.
Individual Analyst Opinions
POSITIVE RATINGS
Aperion-Buy: report date 03/23/05
The analyst upgrades SKS to ‘Buy’. The analyst recommends purchase of SKS shares particularly for the investors with a long-term horizon based on the belief that the company is on the right track to improve overall operations.
FTN Midwest – Buy: report date 03/22/05
The analyst believes that the current initiatives by management represent the last, best opportunity to improve returns for the company. They also believe that there is room for them to deliver on these initiatives with improved operating margin over the next two years. They continue to like the stock.
NEUTRAL RATINGS
Banc of America – Neutral ($16): report date 03/22/05
“Trends remain lackluster and we continue to have a cautious stance on the group, particularly at the high end. In addition, while Saks management has long experimented with interesting approaches to differentiating and driving its business, execution has lagged”.