J.C. Penney: On A Positive Trajectory Through Incremental Changes

| About: J.C. Penney (JCP)

Summary

A report indicated that J.C. Penney would need to close 320 stores to return to 2006's sales per square foot levels.

However, J.C. Penney has positioned itself to be profitable and competitive at much lower sales levels.

Sales per gross square foot have decreased 32% since 2006, but SG&A per gross square foot has also gone down 28%.

Since 2011, sales per gross square foot have gone up 12%, while SG&A per gross square foot has gone down by 3%.

Data-driven approach plus improved communications with store-level employees have identified many areas of potential incremental improvement.

There was recently a report from Green Street Advisors that estimated J.C. Penney (NYSE:JCP) would need to close 320 stores (31% of its total stores) to return to 2006's sales per square foot levels. However, it is important to note that J.C. Penney has positioned itself to be competitive with a much lower sales per square foot than in 2006. J.C. Penney's sales per gross square foot have fallen 32% since 2006, but its SG&A per gross square foot has declined by 28%. As a result of improved efficiency, J.C. Penney is more likely to selectively trim its store base rather than implement the large scale store closures that Sears has been doing for the past few years.

Trends In Sales And SG&A Per Square Foot

J.C. Penney's sales have been rebounding since 2013's low of $107 per gross square foot, and have increased to $120 per gross square foot in 2015. This is still well below 2011's $154 per gross square foot number and 2006's $177 per gross square foot. The 2006 numbers include Internet sales (similar to now) but exclude the catalog business that J.C. Penney later exited in 2011.

As sales fell in recent years, J.C. Penney significantly reduced SG&A costs to partially compensate. SG&A per gross square foot was reduced from $46 in 2011 to $37 in 2013. Since then, sales per gross square foot has gone up by around 12%, but J.C. Penney has further trimmed SG&A per gross square foot by another 3%. This trend is expected to continue in 2016, with guidance calling for sales of approximately $125 per gross square foot, while SG&A is expected to be $36 or lower per gross square foot.

2006

2011

2012

2013

2014

2015

Sales Per Gross Square Foot

$177

$154

$116

$107

$113

$120

SG&A Per Gross Square Foot

$50

$46

$40

$37

$37

$36

Click to enlarge

While sales per gross square foot are highly unlikely to return to 2006 levels (at least without high inflation), SG&A per gross square foot also is quite unlikely to return to 2006 levels. J.C. Penney's operating margin per square foot is lower now due to a lower gross margin percentage, but the SG&A reduction has allowed J.C. Penney to potential reach profitability in 2016.

Please note that my number for SG&A per gross square foot in 2006 is just an estimate as I attempted to remove estimated catalog related SG&A expenses.

Comparison With Sears

Sears (NASDAQ:SHLD) was cited as another department store that needs large amounts of store closures (43% of stores) to reach 2006 productivity levels. However, the difference with Sears is that it already has closed a huge amount of stores without managing to halt its decline in sales per square foot.

Sears had 935 full-line Sears stores and 1,388 K-Mart stores in 2006. This decreased to 705 full-line Sears stores and 941 K-Mart stores at the end of 2015. On the other hand, J.C. Penney actually still had 1.5% more store space at the end of 2015 than it did in 2006.

Sears also doesn't seem to be making the same improvements in costs per square foot that J.C. Penney has been making. The SG&A cost per K-Mart store is the same in 2016 as it was in 2006. Total SG&A has declined significantly, but only due to store closures rather than improvements in costs per store. It is harder to figure out how much Sears Domestic SG&A has changed on an apples-to-apples basis from 2006 due to Sears spinning off various units.

J.C. Penney has managed to improve its sales per square foot in recent years without needing large-scale store closures, and has also markedly decreased its costs per store.

Incremental Improvements

A recent Fortune article (note: there is a video that autoplays) about J.C. Penney had a lot of good information about Marvin Ellison's data-driven approach as well as his efforts to get senior management and store employees in sync. J.C. Penney faces some long-term challenges with quite a few of its stores located in weaker performing malls that are continuing to see significant mall traffic declines. However, it also appears there are enough incremental improvements that J.C. Penney can make to keep growth going for the next few years at least. Ellison also appears to have a rational outlook on the business, aiming for consistent profitability rather than trying to dramatically remake J.C. Penney.

Conclusion

J.C. Penney has effectively managed to cut costs to a level more appropriate for its current productivity. As well, it has managed to increase sales in the last couple of years while also slightly reducing SG&A cost per square foot. This is an impressive achievement. While it is very unlikely to return to its peak productivity levels, it can be a consistently profitable retailer. If it can accomplish that and reduce its leverage, then it can potentially think about bigger moves.

I still think that a $9 to $12 valuation range is fair for J.C. Penney right now, with the long-term target being potentially a fair bit higher if it can continue to improve efficiency. With its pullback to around $9.50, I have started a small long position in it again and may increase it in the coming days depending on the share price.

Disclosure: I am/we are long JCP.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.