J.C. Penney (Photo credit: Sam Howzit)
The precipitous decline at 111-year old J.C. Penney over the past 17 months has been reported ad nauseam, culminating with CEO Ron Johnson’s ouster this month and the return of his predecessor Mike Ullman to lead the chain.
After Johnson eliminated coupons and sale events and started transforming the department store into a sea of mini shops from brands like Martha Stewart and fast-fashion retailer Joe Fresh, Penney shoppers defected in droves, and sales plummeted.
But Penney’s symbolic retail twin, Sears, founded in 1893, has also been on a downturn, albeit a lower profile one that’s been slow and steady, and took flight when hedge fund guru Eddie Lampert took over the chain in 2005 as chairman.
Lampert, Sears’ largest shareholder, orchestrated its merger with Kmart that year, and the retailer has been posting sales declines ever since.
The Standard & Poor’s report from credit analysts David Kuntz and Ana Lai sizes up the chains’ management strategies in the context of the rough-and-tumble retail sector. It explores if Penney and Sears can reverse course and pull off a recovery — or not.
Sears, Penney Downfall Echoes Big Automakers
Sears and J.C. Penney’s parallel declines are reminiscent of General Motors Co and Ford Motor Co., the report says.
“We think the strategic and financial issues they’re now facing and current credit quality (both are rated in the ‘CCC’ category) could be compared to the difficulties that two other emblematic American consumers companies – U.S. automakers Ford Motor Co. and General Motors Co. – encountered a few years ago,” the report said. “The car makers suffered from longstanding competitive pressures that impinged on their financial performance to the point of restructuring.”
The carmakers have since rebounded, winning back consumers from product improvements while lowering costs.
But “Will J.C. Penney or Sears manage a similar rebound in the next few years?” the report asks. And if so, “will a financial restructuring [which would impact its suppliers, employees, landlords and other stores in the mall] play a part?”
Ill-Fated Moves By Activist Investors
J.C. Penney and Sears’ troubles started with bad decisions by activist investors.
For one, “How was [J.C. Penney] allowed to undertake such a risky transformation with regard to its ‘shops’ concept and promotional strategy? It all began when an activist shareholder group allowed then-CEO Ron Johnson and his management team to enact a ‘bet the farm’ strategy,” the report said.
Those shareholders are Pershing Square Capital Management, which is led by investor wunderkind Bill Ackman, and Vornado Realty Trust, which combined, control more than 20% of Penney’s shares, granting them big sway over the company.
With Pershing and Vornado’s blessings, Johnson eliminated 590 sale events and coupons at the highly promotional chain in one fell swoop, as he quickly moved to transform the middle-of-the-road department store into a sea of upscale mini shops.
“Retailers typically test a market first, and then review results,” the report said.
“In our opinion, Pershing and Vornado backed Mr. Johnson and his management team to undertake a complete makeover of JCP without trying it out on a limited basis first, which we believe was a very risky move.”
Look for “meaningful changes” to that ill-fated strategy over the next few months under the leadership of Ullman, according to the report.
Meanwhile, Sears’ Lampert conceded long ago that he had no retail experience to speak of when he took over the chain. “When people say I don’t know anything about retail, I tell them, ‘talk to my mother, and she will corroborate that,’” Lampert said at a Sears shareholders meeting I attended back in 2007, pointing to his mother, a Saks Fifth Avenue veteran.
But that hasn’t stopped Lampert from expanding his powers at Sears, taking on the CEO title this year in addition to the chairman role.
“While he is a successful investor, he has no track record in running a retail company,” the report said. “In our view, Sears needs strong merchandising leadership, not financial leadership.”
Since leading the chain, Lampert’s signature strategy has been to spin off various Sears assets to boost its liquidity – from its Hometown and Outlet Stores to part of Sears Canada — and sell real estate, as opposed to investing in merchandising initiatives.
Indeed, “Sears has spent minimal capital expenditures on its store base versus its peers,” the report said, “which has hurt customer service and the overall shopping experience.”
At the time of the Sears/Kmart merger, Lampert sought to expand the Sears brand into the off-mall space by converting unprofitable Kmart stores into the then-new Sears Grand format, where it would sell Sears’ appliances and tools such as the Kenmore the Craftsman brands – the retailer’s most valuable assets. However, “the off mall strategy failed,” and most Sears stores have been shuttered, the report said.
Sears has made some recent strides in its apparel assortment and is investing heavily in a customer-loyalty program, “but overall revenues continue to decline.”
What’s more, laggard Kmart — which has failed to carve a meaningful niche in the discount space when compared to rivals Wal-Mart, the low-price leader, and Target, the cheap-chic mass merchant — weighs down Sears, the report said.
The Forecast: Cloudy For Both Chains
After store traffic continued to sink, J.C. Penney shifted course in February bringing back its weekly sales and coupons. But it remains to be seen if these changes will bring disgruntled shoppers back into the store.
“Given how hard it is to win back customers, we don’t think these changes will reverse the sales trends, though they may help to slow the substantial erosion,” the report said.
Another unknown is the viability of the store-within-a-store strategy that Johnson put in place, as only 10 percent of Penney’s stores have been converted to that new format.
While Johnson had reported that the converted stores were outperforming Penney’s legacy stores, it’s unclear if CEO Ullman will continue the conversion.
“The best case scenario would be a stabilization of same-store sales later this year and moderate margin gains as JCP is able to lower its markdown levels,” the report said.
As for Sears, the company “currently lacks a credible turnaround plan for long-term viability … For a turnaround, Sears needs a more drastic plan to improve its merchandising and invest in its store base, while maintaining its position in appliance and tools retailing,” the report said.
Overall, “We think longer-term success for both [retailers] remains uncertain.”
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