Department store chain J.C. Penney, Inc. (NYSE: JCP) has been around a long time, but longevity is not a predictor of success. The famous mall anchor store was founded in 1902. Since then, the company has grown into a chain with over 1,000 locations spread across 49 states and Puerto Rico, but it has also had some difficulties. The stock traded as high as $87.18 in 2007, and it has fallen consistently since. As of the end of November 2015, J.C. Penney is selling at roughly $8 a share. The department store chain also stopped paying a dividend in 2012.
That said, the stock price is an improvement. In February 2014, JCP stock dipped as low as $4.90 per share. This recovery has some investors thinking the stock may be bouncing back, and late 2015 is a good time to open a position. Before you buy in, the following are some of the biggest risks of investing in J.C. Penney stock.
Sustaining Progress and Private Labels
One issue J.C. Penney faces going forward is sustaining the progress it has made to this point. The company was showing gross margins of 37% at the end of Q3 FY2015, which puts it close to its pre-crisis gross margins of 39%, but go back further. JCP was showing gross margins of 39% in 2010, and slipped. One solution JCP has for sustaining the progress it has made is by selling more private labels. The product lines and brands the company owns have higher margins; however, it takes a lot of work to convince someone a private label is just as good as or better than the brand she has been buying. Given that J.C. Penney has over 50 private brands throughout its stores, it is a risk investors should consider. After all, what happens to all that product if customers choose national brands instead?
While it is true that JCP has had private labels since 1914, some brand concepts are riskier than others. Take apparel for example. J.C. Penney gets roughly 46% of its business from adult apparel sales. Most of its adult apparel brands are lifestyle brands, ranging from casual to business casual with a couple suits thrown in, and this fits into the character of its stores that sell footwear, housewares and small appliances. One of the company’s newer initiatives is slim-fitting, fashion-forward suits for millennial men. There is a very real risk these men may not want to look for such apparel in a department store, let alone in a private brand from a store not known for such things.
J.C. Penney is also focused on its omni-channel efforts in a bid to let customers move between digital and brick-and-mortar shopping experiences seamlessly. To this end, the company is boosting its website and app capabilities, introducing same-day pickup and offering ship-from-store options. The push makes sense. Almost half of the traffic to J.C. Penney’s website comes from mobile devices, and online capabilities are essential to modern digitally savvy shoppers. The company is also incorporating unique elements into its app, such as letting customers scan a price tag while in the store to read reviews, see product availability and get additional information.
The risk is that much of J.C. Penney’s efforts involve its brick-and-mortar stores. The idea is to drive traffic to the stores, but it also means increased risks with managing inventory, pricing items properly and protecting against security issues. Convenience apps may help, but as more of the retail industry goes online, there is increased pressure to create a unique shopping experience independent of brick-and-mortar stores, especially among younger shoppers.
Sephora, J.C. Penney’s cosmetics and beauty store-within-a-store, offers both digital and in-store shopping options, and it has helped the company attract the millennial demographic. However, Sephora is not structured in a way that drives traffic to J.C. Penney as much as it could. For instance, having a Sephora in a J.C. Penney is a traffic driver, but it does not translate to the website. In fact, Sephora’s website is separate from J.C. Penney’s; there is nothing to indicate the two are related when you look at Sephora’s website. Moreover, while customers can select “Sephora” from J.C. Penney’s website navigation, the selection there is not complete. Also, some Sephora stores are located separately from J.C. Penney department stores.
Betting on Impulse
Increasing store sales and sales per visit is another issue. JCP is trying to encourage customers to visit its locations and spend more per trip by promoting its “Center Core” businesses. This includes impulse buys such as fashion jewelry and accessories, as well as shoes and handbags. The idea is to merchandise these items in such a way that a person buying an outfit can quickly find elements to make the look complete.
The risk with this strategy is many shoppers do not buy their clothing by the outfit. Instead, many are turning toward quality over quantity, opting instead to buy long-lasting, mix-and-match pieces when the price is right. Also, department store sales are down 1.5% year over year for the first three quarters of 2015, so any new business J.C. Penney attracts comes at the expense of its competitors. Investors should understand that if this trend continues, JCP’s idea of arranging a store to encourage impulse buys instead of focusing on the quality and value of its offerings could work against it.
J.C. Penney is simply not achieving the same level of profitability as its peers. The company's return on equity (ROE) is -25% compared to 13.23% for its rival Kohl's, and a whopping 28.31% for rival Macy's. In addition, J.C. Penney is posting a profit margin of -4%, while Kohl's is at 3.9% and Macy's is at 4.8%. In other words, J.C. Penney needs to cut costs or boost sales if it is going to survive.
The department store chain has seen some success with its efforts, including a 6.4% increase in same-store sales for Q3 FY2015 when looking at year over year, but costs can only be cut so far, and the outlook for its sales is not great. When J.C. Penney released its third-quarter results, the company announced it expected to increase same-store sales by 4 to 5% in FY16, and that is for the full year. It is one thing if the company’s net income is reliable, but it is not. J.C. Penney’s net income was -$137 million for the quarter and its earnings per share (EPS) was flat from Q2 FY2015, suggesting the company’s cost-cutting measures are not trickling down to an improvement in earnings.
To help reduce costs further, J.C. Penney has been cutting its overhead through smarter advertising, closing less profitable stores, cutting corporate jobs and reducing its pension obligation. However, while these efforts reduce the present costs, the long-term effect of having fewer stores, less staff and less advertising could take its toll on J.C. Penney’s share price.