Citigroup downgraded Federated Department Stores last week from a “low” to a “medium” risk investment, citing concerns over the company’s long-term success in digesting the former May Department Stores.
The bank also lowered its earnings-per-share estimates and the target price on the stock to $45 from $48.
Citigroup equity analyst Deborah Weinswig said in her downgrade that the former May stores reported slower than expected comparable sales in November. Though Federated is pointing to home as the cause of the sluggish revenue growth, slow apparel and accessories sales also likely contributed to the problem, Weinswig said.
Softer sales at the former May stores may be due to a loss of customers as the stores make the transition to the Macy’s banner from Marshall Fields and Lord & Taylor.
“Our channel checks at Federated indicate that regions such as the Midwest and the West — formerly May stores’ ‘bread and butter’ — have been weak, leading us to believe that market share may be shifting to other players, such as J.C. Penney, Kohl’s and Nordstrom,” Weinswig said. “We may have underestimated how much time it would take for the former May stores to gain traction with the consumer following the Macy’s rebranding.”
Weinswig does note that three factors might bump up Federated’s stock price. First, comps at the former May stores could turn around faster than expected. Second, Federated may realize more synergies from the merger than predicted, which could improve gross margins and reduce expenses. Finally, the possibility of a leveraged buyout would raise the stock price. Still, she cautioned that there were still risks in the Federated and May merger.
After Weinswig’s downgrade, Citigroup’s U.S. Equity Strategy Group removed the stock from its “Recommended List” and replaced it with J.C. Penney.
In a separate research note, Weinswig said J.C. Penney “is evolving from a turnaround story to a growth story that will be driven by sales, square footage and EPS growth over the long term. In addition, we believe the company’s increased brand-focused marketing and operating initiatives, such as cycle-time reduction and better inventory flow, should drive a near- and long-term decrease in working capital and improve inventory turns.”