U.S. department stores are by and large set to report far better earnings in the coming week than they did a year ago in the thick of retail meltdown.

That's the easy part.

The hard part for laggards like J.C. Penney Co Inc , Macy's Inc and Saks Inc will be to show that they can catch rivals like Nordstrom Inc and Kohl's Corp , who won market share during last year's bloodbath.

And for those early leaders, the hard part is to show that they can continue their winning streaks in 2010.

Penney kicks off a weeklong string of reports of department-store results on Friday.

We're going to see earnings growth for almost every department store and we saw good sales over the holidays, said Walter Stackow, a senior analyst with Manning & Napier in Fairport, New York, which manages $25 billion and holds Kohl's and Nordstrom shares.

The flipside to all that bad news last year was the market share opportunity, Stackow added.

Analysts expect both Nordstrom and Kohl's to post strong profit and revenue growth for the fourth quarter, while Saks is set to report a narrower loss despite lower sales as the benefits of lean inventories kick in.

Macy's is expected to report lower sales but higher profits, also thanks to tighter inventory management and cost cutting, while Penney should report lower profits and sales for the quarter.

The shares of Saks, Penney and Macy's may have the most upside, if they can dazzle investors with quarterly results and if outlooks for 2010 show they can win back some of the market share lost to peers and to off-price retailers TJX Companies Inc and Ross Stores Inc in the past year.

At the same time, Nordstrom and Kohl's, whose strong performances are already reflected in their share prices, can see profits rise in 2010 and sales continue growing, analysts said. In January, both reported some of the best comparable-store sales among department stores.

Macy's is still very cheap, and Kohl's, Nordstrom and Penney are all relatively inexpensive considering where earnings can recover to in the next two years, said Liz Dunn, an analyst at Thomas Weisel Partners.

CATCHING UP

Nordstrom won market share from consumers trading down a rung from premium chains such as Saks and Neiman Marcus Group Inc and managed product assortment so as to avoid losing shoppers to Macy's, Stackow said.

Saks is showing signs of improvement, and is expected to report a narrower loss of 2 cents per share on revenues 4.4 percent lower, according to Thomson Reuters I/B/E/S.

StarMine Smart Estimates, which puts more weight on recent forecasts by top-rated analysts, are less optimistic and expect Saks to lose 4 cents a share, a potential downside surprise of 10.3 percent.

The New York chain posted stronger-than-expected same-store sales in January, buoying hope its high-end shoppers were finally returning.

Wall Street is expecting Nordstrom's profits to more than double and reach 79 cents per share, and for revenues to rise 10 percent, compared with a year ago.

Further downmarket, Kohl's has put a dent in Penney, which has been hobbled by its bigger exposure to malls, where traffic has fallen sharply, analysts said.

Penney is just now beginning to catch up to rivals with improving margins. Still, its same-store sales fell 4.6 percent in January, compared with Kohl's increase of 6.5 percent.

Penney and Macy's in particular could benefit if shoppers start trickling back from Ross Stores and TJX's TJ Maxx chain.

I do think there's been a dramatic shift toward off-pricers that may start to stabilize, said Dunn.

LITTLE FAT LEFT

Retailers will likely stay conservative in how they manage inventories this year, lest they lose the hard-won margin gains they've made. But they are running out of ways to squeeze out more profits, absent a resurgent retail environment.

They've cut the expenses to the extent they can, and now you really need to see sales growth to drive earnings per share, Dunn said.

The pressure to squeeze out more profits may require more attrition of underperforming stores this year.

We'll see more stores close than open in 2010, Stackow said.

While the S&P's retail index has risen 80 percent since last March when the stock markets began rising again, analysts said the retailers' shares remain undervalued.

Macy's shares rose 167 percent and Saks rose 291 percent in the same period, recovering after shriveling in the preceding months.

But the current choppiness of the broader stock markets could stop any stock surges in their tracks.

The market is dysfunctional right now, said Richard Hastings, an analyst with Global Hunter Securities.

(Reporting by Phil Wahba; Editing by Gary Hill)

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