J.C. Penney (JCP) recently announced an update on its November sales. The 10.1% same-store growth sounds impressive, but was largely achieved due to an extremely poor November 2012 that was affected by Hurricane Sandy and a Black Friday opening that was later than its competitors. That growth rate will likely not carry over to December and January due to those one-time factors. We are going to estimate what December and January sales are based on November's historic percentage of Q4 sales and assess what that means for Q4 results.
Q4 Revenue Estimate
From 2008 to 2011, November sales represented an average of 31.7% of Q4 sales. November 2013 sales are estimated at $1.242 billion based on the reported 10.1% same-store sales increase, minus $3 million in sales lost due to closed stores. Extrapolating Q4 sales from the November number gives us a total of $3.918 billion. December and January sales would therefore be $2.676 billion, which represents same-store growth of approximately 3.6%.
Dec + Jan
Total Q4 2013
Note that Q4 FY2012 included an extra week of sales, which increased sales by $163 million and SG&A by an estimated $50 million. Without that extra week, Q4 FY2012 sales would have been $3.721 billion.
Q4 Gross Margin Estimate
In prior updates, J.C. Penney had mentioned gross margins, but in the November update there was no mention of gross margins. The missing information about gross margins likely means that November's gross margin was below October's levels (estimated at 30% to 31%) since J.C. Penney would have likely mentioned any sequential gross margin increases. While J.C. Penney may still meet its guidance for sequential improvements in gross margin (above 29.5%), it is likely not going to come in much above that mark for Q4. We are therefore estimating Q4 gross margin to be at 30%.
Q4 SG&A Estimate
J.C. Penney left itself a lot of wiggle room by guiding SG&A below Q4 FY2012 levels. Q4 FY2012 had 14 weeks, and that extra week resulted in approximately $50 million in extra SG&A expense.
Q3 FY2013 SG&A expense was $81 million below Q3 FY2012 levels, but we anticipate that the gap will be closed despite the extra $50 million in SG&A expense incurred last year due to the 14th week.
The reasons are:
- An additional $10 million to $15 million in SG&A expense by opening at 8pm on Thanksgiving plus four additional hours of Black Friday operations compared to last year.
- Lower 2012 holiday spend due to Ron Johnson's promotional strategy. Under Mike Ullman in previous years, Q4 SG&A spend was approximately 10% higher than Q3. Last year, this decreased to a 6.6% increase (after factoring out the 14th week) due to reduced advertising spend. Measured media spend in Q4 2012 was around $60 million lower than 2011.
- Q3 FY2013 advertising spend was also $22 million below Q3 FY2012 levels. Some of the 2013 advertising budget was likely saved for a strong holiday season push.
Therefore, we anticipate a 10% increase on Q3 FY2013 spend levels, after the $22 million reduction in advertising spend levels is added back in, plus an additional $10 million to $15 million in SG&A expense due to longer operating hours over Thanksgiving/Black Friday. This gives us SG&A of $1.145 billion.
Q4 FY2013 Estimates
Putting the above together with the other information that J.C. Penney provided in terms of guidance gives an expected loss of $266 million for J.C. Penney in Q4.
J.C. Penney's results are most sensitive to changes in gross margin. A change in gross margin from 30% to 29% would increase J.C. Penney's net loss by $39 million. A change in net sales of $100 million would only affect J.C. Penney's net loss by $30 million.
(in $ Million)
Depreciation and Amortization
Total Operating Expenses
Net Interest Expense
The Prisoner's Dilemma
This highly competitive retail environment resembles a prisoner's dilemma situation. One department store decides to offer steeper discounts or open on Thanksgiving and then other department stores are often forced to keep pace or suffer greatly. However by matching the opening times and discounts, department stores are left with higher costs and lower margins, with limited top line gains since all department stores are on an equal footing again. The ideal situation would be for retailers to hold off on heavy promotions and extra opening hours, but that's not going to happen.
J.C. Penney paid a heavy price for allowing its competitors to open six hours earlier on Black Friday last year. This year J.C. Penney matched opening hours, which helped its top line numbers, but also added to SG&A expenses - likely negating the profits from much of those revenue gains.
Even Kohl's (KSS) decision to open for 100 straight hours before Christmas will have some minor impact on J.C. Penney. It is unlikely that the additional opening hours will be worth the additional cost, so it makes sense for J.C. Penney not to match that. However, J.C. Penney will still likely lose a few million in sales due to Kohl's expanded opening hours.
As J.C. Penney is in the most precarious position among its competitors, it can ill afford the additional costs and margin pressures from this competitive environment.
Despite a solid start to the holiday quarter, it appears that J.C. Penney is on track for another heavy loss. We estimate that J.C. Penney will lose $266 million in the holiday quarter, which is typically the strongest quarter for department stores.
The results overall seem a bit mixed for J.C. Penney. On a positive note, J.C. Penney is showing around 3% to 4% of actual growth after being flat versus multi-year comps for several quarters. On the other hand, this growth appears to have come at a cost to margins and SG&A spend.