Last month, J.C. Penney (NYSE:JCP) announced a much-anticipated change in corporate strategy. Most notably, J.C. Penney radically changed its pricing strategy beginning February 1, by lowering regular prices, doing away with coupons, and vastly shrinking the number of promotions it runs. Most of the investor focus (quite rightly) has been on the possible effects of this new strategy on J.C. Penney's results. However, the nature of these changes is likely to create significant volatility in JCP shares, as the chain's prospects depend heavily on customer response to these new initiatives. Therefore, investors may be able to find safer (and better) returns elsewhere in the department store sector.
Kohl's (NYSE:KSS) may be the biggest beneficiary, particularly over the next 2-3 years. J.C. Penney's management has emphasized that they want to become "America's Favorite Store"; in other words they want to increase their appeal beyond their traditional suburban working class and middle class base. J.C. Penney's newfound aversion to discounting only makes sense in the context of a broader plan to move the chain upmarket (on average), and compete with retailers like Macy's (NYSE:M) and Nordstrom (NYSE:JWN). However, this means less focus on the core customers that Kohl's and J.C. Penney have been fighting over in recent years.
Regardless of how this "transformation" works out for J.C. Penney, Kohl's is likely to gain customer traffic amongst those who seek out the best deals and coupons. While these deal-hunting customers are not the most profitable, some of this increase in sales will nevertheless fall to the bottom line, particularly in light of Kohl's low SG&A costs. In short, Kohl's has won the war amongst the lower-end department stores. J.C. Penney was the last viable competitor there, and it has now moved its focus to penetrating a somewhat more affluent demographic.
Given the ongoing problems at Sears (NASDAQ:SHLD), Kohl's may increasingly have the low-mid priced department store segment to itself. While there are still macroeconomic challenges ahead, it seems like the economy may finally be gaining traction. If that is the case, Kohl's will likely be able to turn its increased dominance of its market niche into significant profit growth. Considering its very modest forward P/E below 11, Kohl's shares therefore have substantial upside.
Disclosure: I am short JCP.