Retail sales in the U.S. grew less than expected in June, but apparel retailers are still holding up.
The U.S. Department of Commerce reported that sales grew by 0.2% in June, lower than the 0.6% expectation but below the 0.5% for May. However, new trends in apparel could help generate new interest in the space. This could be one of the strongest back-to-school seasons we've seen in a number of years.
The key is that retailers should benefit from shoppers adapting digital shopping trends and mobile apps, assuming they are embracing this new trend. A couple of companies that look to be doing just that include J.C. Penney (NYSE:JCP) and Macy's (NYSE:M).
Is J. C. Penney back on track (or at least getting there)?
J.C. Penney has undoubtedly had problems for the last three years, with a 30% decline in sales. The net loss grew from $152 million in 2011 to $1.4 billion in 2013, pushing down the stock price from $40 at the beginning of 2012 to less than $9 today.
However, the first-quarter results showed the second consecutive quarter of sales growth for the company while guidance for fiscal 2014 pegs sales growth in the mid-single digits. For the first quarter, J.C. Penney managed to grow same-store sales by 6.2%. What's most exciting is that appears to be gaining traction with its digital platform. Online sales grew by 25% during the first quarter.
It also recently replaced its credit line of $1.85 billion with a new line of $2.35 billion and at what management said was better terms.
The gross margin question
The big overhang for J.C. Penney is the margin pressure and the fact that it might be running out of ideas to boost the share price. It looks like costs have already been cut deeply. But if we dive a bit deeper, it looks as if there's room for more gross margin improvement.
Currently, the gross margins for peers Kohl's (NYSE:KSS) and Macy's stand at 37% and 40%, respectively, while J.C. Penney's has been as low as 30%, which is among the lowest in the industry. That number was up to 33% as of last quarter. There might be more room for improvement as the retailer shifts away from unprofitable brands.
An improvement in the gross margin to around 36% would boost earnings before interest, taxes, depreciation, and amortization to the hundreds of millions of dollars given the present sales growth. Ultimately, J.C. Penney would like to boost its gross margin to be more in line with Macy's 40%.
Macy's has managed to expand its margin into one of the best in the industry thanks to its integration of a solid omni-channel strategy.
Attacking the omni-channel
Macy's is a pioneer in the omni-channel, which includes using various channels to promote and sell products. It started its omni-channel diffusion in 2008. It's grown its strategy into what it calls MOM, which stands for My Macy's, Omni-Channel, and MAGIC Selling.
The combination of the three allows Macy's customers to see what's available in stores via online, but it also localizes the merchandise and marketing efforts. Macy's also has an omni-channel strategy in about a fourth of its stores, where it utilizes the automatic ordering of inventory thanks to the system's ability to anticipate inventory needs.
With the help of its omni-channel, Macy's saw sales grow nearly 5% in 2010, and then 5.5% in 2011, followed by 5% in 2012. Sales in 2013 were up just 0.9%, but its net income grew a healthy 6%.
After seeing the success of Macy's, J.C. Penney is adopting a similar model. In 2011, J.C. Penney had two different strategies -- one for stores and one for online. Online had its own exclusive merchandise. Therefore, customers shopping in stores could no longer use the online store to find what they needed in case the physical store didn't have the product available.
Online sales fell 32% in 2012. Then the company stopped coupons and discounts, which further alienated its customers. Online shoppers are generally more price-conscious, and without discounts, shoppers had no reason to shop online. It reintegrated online and physical stores in 2013. Online sales were up 6% in 2013 and then in the first quarter of 2014 grew 26% year over year.
Stacking up Penney's shares
J.C. Penney looks cheap from an enterprise value-to-sales (EV/sales) and P/B basis. These ratios are 0.59 and 0.97, respectively. Compare that to Macy's EV/sales of 0.94 and P/B ratio of 3.47, and Kohl's trades at EV/sales of 0.78 and a P/B ratio of 1.85.
Despite being so cheap, turnarounds are never easy in a competitive industry like retail. A highly leveraged balance sheet like J.C. Penney's doesn't help either. However, the potential for margin expansion looks to be achievable.
While Macy's has managed to navigate the financial crisis nicely, thanks to its omni-channel adoption and high-end customers, J.C. Penney is looking to follow suit with the omni-channel and hopefully recapture some lost market share. Its margins have been improving, and it has a strategy in place. This could make J.C. Penney one of the more interesting turnaround stories next year. For investors with an appetite for the risk, shares of J.C. Penney are worth a closer look.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.