JC Penney crawls out of bargain basement

“My whole house is JC Penney right now,” said Lisa, a 28-year old graphics designer shopping at the retailer’s Manhattan Mall store in New York. “I’m renting a new apartment and I set the whole thing up with JC Penney merchandise”.

Obituaries were being drafted for the 114-year old department store chain three years ago. But Wall Street is starting to show similar enthusiasm as rising sales and lower costs improve gross margins and new management takes steps to extract value from its properties.

Against a backdrop of chronic gloom over other venerable US department stores, JC Penney has started to reverse the 81 per cent decline in its shares between 2012 and 2014.

After a modest 3 per cent gain last year, the stock has soared 60 per cent so far this year, eclipsing the 12 per cent gain for the S&P 500 department store index. The yield on JC Penney’s bond maturing in October 2019, which moves inversely to price, has fallen 5.08 percentage points to 6.78 per cent since January.

This week, the turnround earned JC Penney an upgrade from rating agency Standard & Poor’s, which on Wednesday raised the department store’s credit rating to ‘B’ from ‘CCC+’ with a positive outlook.

Investors’ excitement stems from what has unfolded on the shop floor: last year same-store sales rose 4.5 per cent . It is a far cry from 2011 when, losing customers and facing disruption from internet competitors, JC Penney brought in Ron Johnson as chief executive.

It hired the former head of Apple’s retail operations, hoping some of the glamour of the iPhone maker’s stores would rub off but the experiment lasted less than two years. JC Penney’s shares and sales plunged further and it was left with $5.3bn in long-term debt by the end of the first quarter of 2015.

Myron Ullman returned as chairman in April 2013, bringing back discounts and private brands. Then Marvin Ellison, who helped turn around Home Depot, took over as chief executive last August.

Together, they have done some of the basics, including cutting costs. JC Penney’s selling, general and administrative costs fell 2.7 percentage points last year, and this year it ended its 14-year sponsorship of the Academy Awards to reach new customers through savvier digital marketing.

The scale of its turn in fortunes poses two questions: can it last; and does it hold lessons for struggling rivals such as Macy’s and Kohl’s, whose sales have been eroded by competition from ecommerce, off-price retailers such as TJX, and fast fashion chains such as Zara and H&M.

Omar Saad, an analyst at Evercore ISI, points out that generating brighter annual comparisons has been easier for JC Penney than rivals, given how sharply its sales had fallen — they were down almost 25 per cent in 2012. However, he adds: “We are significantly more impressed by JC Penney’s ability to sustain that momentum over the last two quarters when the total apparel retail complex has come under significant pressure.”

The company says its challenge is to win back once loyal customers and make existing shoppers return more frequently.

To do so, Mr Ellison has focused on survey data, which has shown him that the Nike brand draws teenage boys into its stores, or that customers who shop both in store and online spend 2.5 times more than average.

Analysts say expanding its range of brands, including private labels axed under Mr Johnson and so-called shop-in-shops like Sephora or Disney, will also be critical if it is to differentiate itself and keep raising margins.

“Consumers have many choices, and competing purely on price is almost always a no-win situation for anyone,” says Daniela Nedialkova, an analyst at Atlantic Equities.

The consumer spending backdrop may be getting less benign, however. The Federal Reserve has signalled that it expects to raise interest rates twice more this year, while oil prices have been creeping higher, crimping the benefit consumers had enjoyed from lower fuel prices.

Chris Terry, co-portfolio manager of Hodges Small Intrinsic Value Fund, whose parent Hodges Capital has a 1.5 per cent stake in JC Penney, believes it can beat such headwinds. “Inventories and margins are moving in the right direction and that tells us all that we need to know about the health of the top-line,” he says.

The company has “a lot of tricks up [its] sleeve to raise cash and monetise real estate”, Mr Terry adds. In February, it put its headquarters in Plano, Texas on the block, hoping to lease the building back and generate as much as $500m.

For now, Wall Street sentiment continues to improve. Just 15.4 per cent of the 26 analysts who cover the company recommend selling the shares, down from 44 per cent a year ago. 

JC Penney’s turnround is far from an overnight phenomenon. It is almost three years since it aired ads saying it had learned from its “mistakes” and asking shoppers to come back. 

“We learnt a very simple thing: to listen to you,” the ads said. The reaction of shoppers such as Lisa suggest that message may finally be reaching customers.