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Beaten-down department store stocks could be ready to rally

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Scott Olson | Getty Images

Department store stocks have tumbled 13 percent since the chains started reporting holiday sales results last month. But the struggling retail segment may soon be poised for a rally.

Despite long-term threats from declining store traffic, a shift in consumer spending toward the web and off-price stores, and weak sales trends, Morgan Stanley analyst Kimberly Greenberger said these chains could experience a rally after they report fourth-quarter results next week.

That's because investors' views on the group are so pessimistic, and it will be facing its easiest first-quarter comparisons since the recession in 2008 and 2009. In particular, Greenberger upgraded J.C. Penney shares from underweight to equal weight, citing less risk given their double-digit decline this year. Still, the analyst cautioned that any bounce in the space would likely be short-lived.

"We've seen the 'easy compare' script before," Greenberger said, referring to the third and fourth quarters of 2016. "[We] would use any strength into first quarter earnings per share prints in May to trim positions."

Macy's kicks off department store earnings reports on Feb. 21. Expectations for the sector are already dim, as Macy's, Kohl's and Penney's previously reported lower comparable store sales for November and December. Instead, analysts will be watching the companies' fiscal 2017 guidance.

Investors will also be eyeing Macy's for updates regarding a potential sale. Barron's said the chain's shares could rise 50 percent if it were to be acquired. This assessment followed reports that the retailer is exploring a sale. Yet even with a spike in share prices following those reports, Macy's stock is down nearly 9 percent this year.

Cowen & Co. analyst Oliver Chen told investors that even if a deal were to come through (Saks' parent Hudson's Bay was rumored as a potential buyer), Macy's fundamental challenges would not disappear.

"A buyer would likely need to be excited or prepared to execute better than current management with respect to a turnaround," Chen said.