Wednesday, December 5, 2012

The JCP Turnaround: Don't Write It Off

J.C. Penney, a century old name in U.S. retailing, has been badly under managed for many years.  We've largely seen the demise of the traditional department store, with a few exceptions. Growing up, my family took me shopping at J.C. Penney for my school clothes--white shirts and navy blue pants--because Penney's had good quality clothes at lower prices than Macy's.

Over time, their brand assortment became an incomprehensible jumble, and their lead private label brand Stafford became real junk.  At the height of apparel outsourcing to China, Penney's gave up every quality detail in softlines for a few margin points in initial markup.  Inside the store, most of the table tops became dump tables like Odd Lots, as their coupon-mad customers threw around merchandise looking for mispriced items on which to use their fistfuls of coupons.  None of this happened overnight: it went on, unchecked, for years.

When Kohl's pulled the rug out on MSRP for clothing, and went with their low cost, high efficiency stores, it was a shot across the bow for retailers like Sears and Penney's.  The latter were in costlier mall real estate and  wedded to a high IMU, heavy markdown model with incessant coupon circulars.  I'm not sure who the Penney's customer is; I think that you see them go from Penney's into Marshall's, looking for more junk at heavily marked down prices.  JCP was on its way to the retail grave yard before it undertook the current turnaround with CEO Ron Johnson and his team, which is nine months into the turnaround.

I used to put the Penney's Sunday circular unread, straight into recycling until the appearance of the new logo  and look caught my eye.  For the first time, it seemed as if someone like my daughter and my wife might have cause to leaf through the merchandise.  That certainly sent a good signal.

The current turnaround is being criticized because it may have driven away their coupon-addicted customer. Where is this customer going for clothes?  Wal-Mart?  Marhsall's?  Sears?  If they are the store's "cherry picker" customers, perhaps they need to go somewhere else, because a chain can't thrive on serving them with this model.

The daughters of the customers, while they are in the mall, are going to sales at American Eagle and Old Navy.  The clothes are generally junky, but they have style, which JCP has traditionally lacked in their merchandise offering.  Under the new advertising, JCP is clearly trying to change its image and to close this fashion gap.  These customers can be won back.

Having worked in a lot of front-end and back-end retail operations, I can tell you that JCP had lousy, unmotivated buyers and merchants and a dispirited store staff, a deadly combination which produces the assortment that the retailer had to coupon so heavily.  Hopefully all of these functions will be turned upside down and reenergized.

Although the new CEO's background at Apple retail has been incessantly trumpeted, I note that his tenure as VP of Merchandising at Target, will be equally, or perhaps more valuable to new investors.  Target is a heavily planogrammed, highly disciplined, merchant-driven buying and selling operation.  This kind of discipline should yield great benefit at JCP.

Even Target does a mediocre job in its private label clothes.  Merona, its flagship private label apparel brand, had much better advertising than its product.  It has gotten better, and its sales increased.  Private label is not easy to do well, and JCP used to do a horrendous job.  They should only do better.

For the most recent quarter and the nine months, JCP traffic is down and comps were down 12% for the quarter, the third consecutive quarterly decline.  The GAAP gross margin rate declined year-over-year from 37.4% to 32.5% in the current period third quarter.  As the management explained, however, the marking down and clearing of current and outdated inventory, as well as the elimination of a traditional month-long, intra-quarter "value price" all contributed to the decline in the GAAP GMR.

Overall, clearance was a lower percent of third quarter business than it was in the prior-year period. Looking at gross margin realizations at "every day low prices," the rate was 48.1% in the prior-year period, compared to 51.7% in the current third quarter.

Store expenses seem to be in line with management guidance, although there is definite evidence from the stores that you need a GPS system to find help in the store.  This level of staffing and training can be raised as the better merchandise assortment and value pricing starts to take hold.  There's no guarantee that it would, but this kind of reimaging has been done before at Target and elsewhere.

The company also has the advantage of some strong institutional shareholders already.  Pershing Square, which unsuccessfully took on Target, owns 17.98% of the equity.  Vornado Realty Trust (10.77%),  and Evercore (6.74%) are also among the active shareholders. The CEO himself owns 3.62% of the equity, and directors and officers as a group own 31.7%.  Having the CEO invested as well as other insiders, along side a strong institutional base is a good thing.

It's early to say this, but I wonder about Penney's commitment to housewares and small appliances.  If they keep their same merchandise focus, I feel that the day has been lost to Kohl's and Target.  Penney's would be squeezed between these two giants, unless it comes up with a unique merchandising mix and value proposition. Let's see how this goes.

I'm not suggesting that this is the right comparison, but Von Maur has built a very successful model built on limited assortments of high quality apparel, beauty, and gifts, limited sales, and high service levels.  They don't sell cutlery, china, or kitchenware appliances as traditional department stores did.  It may be something to consider later.

Sometimes, a successful business has to "fire" some of its customers.  JCP's coupon-addicted customers and their disappearance from the traffic flow needs to be investigated.  It might get worse before it gets better, but JCP surely had to undertake the current kind of transformation if it wants to remain an iconic retail brand.

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