David Jones and Myer slug it out

Saks (famous for its iconic Fifth Avenue store in New York) has received a takeover offer from the Canadian department store group Hudson’s Bay. Saks got into trouble from ill-advised expansion leading to a number of poorly performing stores, and the offer values Saks at a massive 38 times expected 2014 earnings. Evidently, North American trade buyers don’t see department stores as dinosaurs (unless poorly managed) – instead they are seen as potentially robust retail franchises.

Does the Saks takeover have any relevance for Aussie department stores? First, there is no suggestion they deserve a PE of 38, however there are some interesting parallels.

Myer (ASX: MYR) trades at 11 times earnings and David Jones (ASX: DJS) at 15 times. Both have high dividend yields – Myer, 10.3% grossed up, and David Jones, 9% grossed up. By global standards both domestic department store groups appear undervalued.

However, price earnings ratios and yields don’t necessarily reveal the intrinsic value of a company. Underlying assets and possessing the financial capacity to invest in business growth are frequently more significant criteria when assessing a company’s future, especially in challenging times.

For example, a major attraction of Saks is its real estate portfolio (comprising fully owned stores), valued at $1.5 billion (or 47% of capitalisation). By comparison, David Jones’ property assets are valued at $600 million (or 41% of capitalisation). Myer has no property assets.

When it comes to the balance sheet, Saks has a debt to equity ratio of 27%, Myer is equivalent with 27%, and David Jones is a restrained 8%. On gross profit ratios Myer leads the way with 41%, Saks is next with 40% and David Jones comes in third at 39%.

Myer’s present operational advantage was achieved in a period of private equity ownership – away from Mr Market’s impatient eyes. The owners invested heavily in upgrading administrative, marketing and technology systems, developing store labels and improving premises. During the same period, David Jones did a little cost cutting and had limited initiative.

However, since 2012 David Jones has itself been putting levers in place for much improved operating performance. Results should be apparent over the next two years.

Foolish takeaway

On basic ratios, Myer appears a better buy – however, it has mildly negative net tangible assets (-5c per share), $1.60 of intangibles per share and 72c of borrowings per share. These factors will limit the financial scope should further retail challenges lie ahead.

David Jones has net tangible assets of $1.46 per share, 9c per share in intangibles and 14c of borrowings per share. These metrics allow David Jones the capacity to invest in the business and meet future challenges. To this Fool, DJS is the better growth prospect.

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Motley Fool contributor Peter Andersen owns shares in David Jones and Myer.

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