J.C. Penney Escalates Appliance War Vs. Sears

| About: J.C. Penney (JCP)


J.C. Penney rolled out appliances online and in stores for the first time since 1983, with aggressive promotional pricing and financing.

Sears, currently the nation's top appliance retailer, subsequently announced the opening of appliance-only show-rooms with competitive promotions/financing options.

Data indicates that as consumers shift spending from apparel to big-ticket purchases, we can likely expect to see retailers shift inventory, promotions, and floor space towards home goods.

In recent weeks, two struggling retailers on-and-off Wall Street's chopping block escalated their appliance war to halt the ongoing hemorrhaging of current customers from American brick and mortar stores. J.C. Penney (NYSE:JCP), based in Plano, Texas, for the first time since 1983, began selling appliances at a majority of stores (and online) after reporting positive results from the test markets this winter. Their major competitor Sears Holdings Corp (NASDAQ:SHLD), headquartered in Illinois, has long sold appliances under their Kenmore brand, whereas JCP phased out their private brand, Penncrest, over thirty years ago.

In May, Sears Holdings Corporation's CEO Edward Lampert announced the opening of appliance-only showrooms. Given that JCP made their announcement prior to Sears suggests that the new showrooms are a strategic defensive move to maintain their market-leading position in appliance sales. This comes in the wake of this summer's closure of 68 Kmart (also owned and operated by Sears) and 10 Sears stores. Sears recently accrued $1.2b in debt financing to provide resources for the brand's transformation.

"The decision to close stores is a difficult but necessary step as we take aggressive actions to strengthen our company, fund our transformation and restore Sears Holdings to profitability," explained Sears CEO/Chairman Lampert.

The closure of the Kmart and Sears stores may increase Sears' rate of sales per square foot, an important metric the American retail industry is currently over-extended in when compared to foreign markets. A recent report cited both JCP and Sears as having faced a severe decline in sales per square foot over the past decade. According to the report's analysis, to return to their 2006 rate of sales per square foot, JCP needs to close 31% of their stores, and Sears needs to close 43%.

JC Penney Corporation made the announcement this spring that they would once again be selling appliances, beginning this summer, both in-store and online. Omni-channel growth has been one CEO Marvin Ellison's three strategic transformation priorities throughout his short tenure, in addition to a focus on private label brands and revenue-per-customer. These priorities ultimately aim to mitigate JCP's biggest red flag financially: debt, which was incurred heavily under the reign of a recent CEO, Ron Johnson. Johnson was brought in from Apple (NASDAQ:AAPL) and ousted in April of 2013 after what has been quoted as "the worst quarter in retail history" with a comp decrease of 32%.

As far as the specific details of the new JCP appliance offerings, customers will be able to choose from products by GE, LG, Samsung, and Hotpoint. To take advantage of the current price-sensitive climate, JCP offers 18/24 months financing, 20% off some products, plus free delivery/installation, in addition to a price-matching policy. To counter, Sears is offering 12-month financing, 30% off some products, and free delivery/installation on products above a specific price.

One of the expected advantages of the appliance introduction to JCP stores is the ripple effect in surrounding department sales, such as furniture, drapery, and other home décor. The downside risk to the introduction of appliances is the combination of increased store space needed for displays and the low velocity of unit sales, given the high ticket price.

JCP is re-focusing on the home division, as apparel sales continue to plunge throughout the industry. The following chart shows the retailers with the fastest earnings growth % for Q1 2016:

Retailer Sub-Sector Earnings Growth
Marinemax Specialty 400.0%
Marcus Hotels 344.4%
Installed Homebuilding 320.0%
Superior Auto 250.0%
Royal Hotels 185.0%
Boyd Casinos 130.8%
Pool Distributors 100.0%
Ethan Home 88.9%
Hasbro Leisure 81.0%
Drew Auto 76.8%
KB Homebuilding 75.0%
Click to enlarge

Source: Thomson Reuters I/B/E/S

As the above data indicates, consumers during Q1 focused heavily on big-ticket, high-dollar purchases, such as home-related products and experiences, such as tourism. Furthermore, apparel traditionally has one of the highest markup rates of retail products, therefore a decrease in gross margin is a definite risk for firms shifting away their merchandising strategy towards lower-margin areas. However, apparel sales are extremely weather-sensitive, so the increase in home product sales may reduce uncertainty and sales volatility among various financial metrics.

This past May, Home Depot's (NYSE:HD) earnings report indicated consumers are increasing both visits and spending for home items, which resulted in a 6.5% increase in sales at existing stores for Q1. This number stands in stark contrast to the comp declines just reported by apparel-heavy retailers such as Macy's (NYSE:M) with -7.5% and Kohl's (NYSE:KSS) at -3.9%. Therefore, one could reasonably expect to see major retailers shift more space and promotions to home department products.

Simultaneously with the appliance introduction by JCP is also a revamped furniture line partnership with privately held Ashley Furniture. Additionally, they're testing an introduction of in-store floor sales outsourced to Empire Today at select markets. Other initiatives include expanding the number of in-store Sephora (a privately held cosmetic firm) locations and the introduction of a plus-size women's clothing line.

Currently, JCP's home division accounts for 12% of annual sales, and was a top-three ranked division consistently throughout FY2015. The CEO has tasked the division with thirty-percent of firm sales growth over the next five years. JCP financial reports show the home division experienced an impressive 25% growth over FY2015. There are several forces driving this growth. Their home division drove 40% of e-commerce sales, compared to just 15% within stores. In the mid-2000's, JCP drapery was said to cover 1/3 of the windows in America. While Johnson attempted a radical transformation of the brand, the home division, then the second-largest at JCP, lost both significant market share and sales dollars.

Ellison joined JCP in 2014 after a Home Depot role, the experience of which is likely influencing his appliance initiatives. He was initially mentored by Mike Ullman, former CEO, who will retire in August, 2016, passing the Chairman role on to Ellison. Given Ellison's focus of private label brands, this calls into question whether or not to expect an eventual JCP private label appliance brand. In a highly-competitive retail environment, private label brands are prioritized over national brands due to the difference in gross margin.

Ellison told shareholders to expect additional upcoming changes as he continues his strategic transformation of JCP with an ultimate goal of $1.2B EBITDA by 2017. He still maintains that the firm is on track to achieve that goal, despite a recent slowdown across retail.

Although investors may view Ellison's bold strategic changes as possible risk to future growth, the changes comes as no surprise. The intensity at which Ellison is strategically transforming JCP is a tendency outside-appointed CEOs make, according to a 2010 study by Yan Zhang and Nandini Rajagopalan, published in the Strategic Management Journal.

If the JCP appliance introduction is able to steal major market share from Sears, this would be a major strategic blow to Sears' plans for return to profitability. Clearly, with Sears shuttering department and general merchandise stores, they see their only sustainable competitive advantage as the appliance market leader. One advantage Sears has over JCP is their owned private brand, Kenmore. Private brands are associated with higher rates of gross margin. As additional retailers continue to focus on private label brands, one cannot help but wonder if we'll soon be seeing a return a of a private label JCP appliance brand, particularly given Ellison's priorities, career background, and boldness with strategic changes.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.