J.C. Penney Is Missing 1 Essential Ingredient

J.C. Penney’s problem lies not in its margins but with its lack of consumer traffic.

Jan 25, 2014 at 8:00AM

The November to December holiday shopping season was definitely one of a kind, as retailers heavily increased their marketing efforts and promotions like never before. For retailers, it was every store for itself -- who could stir up the most traffic, stay open the longest, and sell the most goods or services.

The holiday shopping season kicked off, as many will remember, with stores opening in the early evening hours on Thanksgiving Day to gain the tiniest of edges over the competition. Macy's, (NYSE:M), J.C. Penney (NYSE:JCP), and Dillard's (NYSE:DDS) all geared up for what would turn out to be a brutal shopping season, working around the clock to gain more sales traffic.

Giving everything it has
The most desperate of these U.S. retailers was J.C. Penney, which has endured a great deal of trouble over the past few years. It experienced a fall in revenue and net profit along with companywide store closures and the recent issuing of shares to raise cash going into the holiday season. There has been a great deal of controversy surrounding J.C. Penney and what it should do to turn itself around.

Rebranding, offering more discounts, and closing unprofitable stores are all options that have surfaced as ways to bring J.C. Penney back to life. However, after looking at the numbers, it is clear that there's just one thing J.C. Penney needs to do to recover at this point.

Margins, margins, margins
At first glance, it might appear that J.C. Penney has a pricing problem. The simple fact of the matter is that Macy's is able to sell its products for higher prices than J.C. Penney. In addition, Macy's is able to discount items by 15% to 25% without taking a hit on profit because it is able to attract larger crowds to its stores and encourage consumers to purchase more than what they originally planned on.

Not only has J.C. Penney not been able to generate this kind of a response, but all other costs associated with being a department store such as real estate and labor have lead to losses for J.C. Penney. Unfortunately, that is just the start of the struggling brand's many problems. Over the past three years, J.C. Penney's gross margin has dramatically fallen, and has continued falling throughout fiscal 2013 from 30.8% in May to 29.5% in November.

Dealing with the real issue
While it is clear that J.C. Penney's gross, operating, and net margins are inferior to those of Macy's and Kohl's, and given that these margins could be fixed over time, the company still wouldn't make nearly as much money as its peers. The reason for this is that its margins are not the real issue at hand. Let's say that J.C. Penney earned a gross margin of 38% in the third quarter of fiscal 2013 rather than the 29.5% it actually made for that period. J.C. Penney would have gained an extra $236 million that likely would have found its way directly to the bottom line.

One might think that surely J.C. Penney would become profitable again, but unfortunately that is not the case. Its net loss for the third quarter of the current fiscal year was $489 million. If the company had exhibited a much healthier 38% gross margin, J.C. Penny STILL would have experienced a net loss of $253 million. Clearly, raising its prices to boost gross margin matters very little as it is missing one essential ingredient.

One little word – Traffic
J.C. Penney's troubles stem from the fact that it can't attract enough foot traffic through its stores or website to generate the sales it needs to thrive as it once did. Running promotions, discounting, or even raising prices to repair its gross margin will do nothing to help its current situation unless it can stir up a boat load of sales. The fixed costs of running the business are simply too high. This simple solution can only be accomplished by getting people to walk through its doors and shop.

Company Name

2010 sales per gross square foot

2011 sales per gross square foot

2012 sales per gross square foot

J.C. Penney 

$153

$154

$116

Macy's

$162

$174

$184

Dillard's

$116

$121

$121

From FY 2011 to FY 2012, sales per square foot dropped from $154 to $116 while Macy's increased its sales per square foot by a full $10. Given J.C. Penney's same- store sales results so far this year, it is fair to say that not only does the fabled retailer need customers fast, its survival depends on it.

Foolish takeaway
Foolish investors holding out hope for J.C. Penney to make a surprise comeback will need to remain patient, as it will take time for J.C. Penney to regain its strength. The best thing J.C. Penney can do at this point is work on getting people in the door; otherwise it will find itself experiencing a deeper sales decline.

The problem is consumers are avoiding J.C. Penney stores all together, walking straight past the entrance as if it were invisible. Foolish investors should keep an eye on J.C. Penney's foot traffic to gauge any sort of increase or decrease before making an investment. Once J.C. Penney can bring the customers it lost back, sales and profits will likely bounce back.

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Fool contributor Natalie O'Reilly has no position in any stocks mentioned. The Motley Fool owns shares of Dillard's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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