The last several years have not been kind to JC Penney. Not only have they been swept up in the long-term decline of the moderate department store sector, but they also hemorrhaged huge amounts of market share during Ron Johnson's failed re-boot. Under current leadership, the picture has not improved much. In fact, last week shares sank again after a disappointing earnings report. The stock is off nearly 90% in the past five years and some 40% year to date.
Many observers have concluded that Penney's is on a slow slide to oblivion. And while I agree that much more needs to be done to right the ship, I am cautiously optimistic. In fact, full disclosure, I bought some Penney's shares at $3.95 earlier this week. While investing in the company is not for the faint of heart, I believe there are a few reasons to believe that the news on Penney's going forward is more likely to be positive than not.
Store closings muddy the picture. The biggest reason for the miss on gross margin was from unusually high markdowns. Both Penney's own store closings and those of competitors put pressure on pricing as stores liquidate merchandise. While clearly the industry is facing a great deal of promotional intensity, margin pressures should subside as the pace of store closings slows.
New initiatives are gaining traction. Penney's continue to expand its partnership with Sephora, opening 32 new locations and expanding 31 others. The beauty category is key to driving incremental traffic. The company also is growing its appliance showrooms and seeing positive sales momentum. The repositioning of its critically important apparel business also seems to be going well, with most categories seeing positive comps despite a difficult market.
Gaining share in a down market. Wall St. is overly focused on same-store sales growth, which I continue to deem retail's increasingly irrelevant metric. With nearly 20% of sales in Penney's core categories occurring online it's more important to understand combined e-commerce and physical store performance on a trade-area by trade-area basis. If Penney's closed a bunch of stores but overall sales grew, it suggests that they gained omni-channel share, which speaks to their improving digital commerce capabilities. While there is considerable room for improvement, that's still encouraging. And unlike some, Penney's seems to get that stores drive e-commerce and vice versa--and they are acting accordingly and wisely.
Well-positioned to gain from Sears demise. While Sears may still technically survive as a holding company for intellectual property, it seems obvious that most of their mall-based department stores will be shuttered within the next year or so. That will give Penney's a crack at hundreds of millions of dollars of home and apparel business, not to mention solid upside from their expanding appliance presence.
Maybe Amazon buys them? Amazon clearly has its eyes set on growing market share in traditional department store categories. And the reality is a physical store presence is going to be required to access the majority of the business. Both Macy's and Kohl's market caps are around $7b. Penney's is under $2b. You do the math.
Of course, even if my prognostications prove accurate, I know other risks exist. JC Penney's is highly leveraged. The Amazon Effect remains real. The off-price sector continues to steal share away from department stores. The full effect of retail consolidation is yet to be realized
However, the broader "retail apocalypse" narrative is nonsense and the notion that mall-based retail is doomed is overblown. Physical retail is different but far from dead. Most malls are not going away. And recent earnings reports from many "traditional" retailers suggest the broader market is beginning to stabilize. Either way, clearly more capacity needs to come out of the market before any of the struggling retailers have any shot at significantly improved performance. For Penney's in particular, they need further work to make their assortments and experience more relevant and remarkable, while right-sizing their store fleet for optimal performance.
Perhaps it's wishful thinking on my part, but I think they are fundamentally pointed in the right direction. Only time will tell.
