Why Are These Department Stores Downsizing?

Since the beginning of the new year, three major department store chains -- Macy's (NYSE: M  ) , J.C. Penney (NYSE: JCP  ) , and Nordstrom (NYSE: JWN  )  -- have announced plans to close some of their stores. However, the store closings come in three very different contexts.

For Macy's, store closings are a way to optimize its retail footprint and maximize profit margins. Macy's operates a vast store network and a growing e-commerce business, so losing a few stores should not impact customers much. For J.C. Penney, closing stores is part of a last-ditch attempt to cut costs in order to reach breakeven before it's too late. Lastly, for Nordstrom, the purpose of closing stores is to devote capital to the most promising growth opportunities.

Optimizing a mature business
Macy's is a mature business today. It has more or less saturated the U.S. market with 840 stores, and so it is no longer focused on growing.

In early January, Macy's announced that while it has several new stores scheduled to open within the next few years, it will also close five stores in early 2014.

Macy's is closing some of its stores, but opening other new locations.

Investors should see these moves as part of a broader strategy by Macy's to optimize its store portfolio. Macy's has taken advantage of its growing e-commerce business to set up its stores as mini-fulfillment centers. This allows Macy's to keep a wider variety of items in stock at each store and to better utilize the real estate and labor associated with each store. This strategy has been very successful so far.

However, while Macy's has offset the slowdown in sales at its stores with strong online revenue growth, organic earnings growth is slowing. (Macy's has used heavy buyback activity to keep EPS growing, though.) Macy's needs to trim store-related costs in order to ensure that its stores remain an asset rather than an anchor.

From this perspective, closing a few underperforming stores seems like a good move. Macy's has other locations in each of the metropolitan areas where it is closing a store. Between these other stores and its growing online business, Macy's should be able to recapture much (though not all) of the revenue it will lose from closing five stores. By shrinking its store base ever so slightly, Macy's may be able to return to margin growth this year.

Stopping the bleeding
In some ways, J.C. Penney's store closings stem from a similar motive. J.C. Penney also has a massive national footprint, which consists of roughly 1,100 stores. The company plans to close 33 of these stores by early May in order to save $65 million in annual operating expenses.

J.C. Penney is closing 33 stores in order to cut costs and get closer to breakeven.

However, J.C. Penney's store closings come in a wildly different context; the company lost more than $1 billion in the first three quarters of 2013. Whereas Macy's is tinkering with its store base -- opening a few stores where it thinks they will be useful, while closing a few others -- J.C. Penney is desperately trying to shore up its finances.

Additionally, J.C. Penney may have more trouble "recapturing" the revenue from the stores it is closing, which will offset some of the cost savings. Many of the stores J.C. Penney is closing are in small cities where there aren't other J.C. Penney locations nearby.

J.C. Penney may try to direct these customers to its e-commerce business. Indeed, the 26.3% growth in online sales last quarter was one of the few bright spots in its recent holiday sales report. Nevertheless, J.C. Penney's retreat from many markets indicates that management no longer expects a rapid turnaround.

Focusing on the big opportunities
Whereas Macy's and J.C. Penney have vast store networks already, Nordstrom is still growing. The upscale department store operator has just 117 full-line stores, along with around 140 Nordstrom Rack off-price stores. The company's plans to close two stores in the Portland, Ore., metro area in early 2015 may seem incongruous in light of its growth ambitions.

However, like Macy's (and, to a lesser extent, J.C. Penney), Nordstrom is hoping to recapture much of the revenue from the stores it is closing. (In fact, Nordstrom executives claim that all of the company's stores are profitable.) After the store closings, Nordstrom will still have three full-line stores and four Nordstrom Racks in the Portland area.

Nordstrom is closing two stores in order to save its capital for better opportunities.

Investors should view Nordstrom's store closings as an attempt to channel capital to the most promising opportunities. In August, 2012, Nordstrom announced plans to more than double the Rack store base from 110 locations to more than 230 by the end of 2016. The company is also entering the Canadian market later this year, and plans to have at least six full-line stores there by the end of 2016.

In other words, Nordstrom has plenty of growth opportunities calling for its cash. As an upscale retailer, it's important for the company to keep its stores looking spiffy, which means investing in remodeling every so often. With better opportunities elsewhere, it made more sense for Nordstrom to close its underperforming Portland-area stores rather than spending money to try to improve them.

Foolish conclusion
Macy's, J.C. Penney, and Nordstrom are all closing some stores within the next year. To some extent, the e-commerce revolution is responsible; as more and more shopping moves online, it makes sense to close "marginal" stores rather than investing in them to improve performance.

However, the contexts are different. Macy's is opening stores at about the same rate as it is closing them, so its moves can be seen as an attempt to optimize its retail footprint. J.C. Penney is truly downsizing: closing unprofitable stores in an attempt to get back to breakeven. Lastly, Nordstrom is not downsizing at all; the company is closing two stores in order to devote its capital to investments that are expected to have higher payoffs.

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Adam Levine-Weinberg

Adam Levine-Weinberg is a senior Industrials/Consumer Goods specialist with The Motley Fool. He is an avid stock-market watcher and a value investor at heart. He primarily covers airline, auto, retail, and tech stocks. Follow him on Twitter for the latest news and commentary on the airline industry!

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