3 Reasons Sears and J. C. Penney Will Continue Failing

Many years ago, a shopping trip to buy clothes for school meant a trip to the mall. When kids would pick out toys they wanted for the holidays, they would browse through the Sears Holdings (NASDAQ: SHLD  ) or J. C. Penney (NYSE: JCP  ) catalog. Unfortunately for both of these retailers, those days are gone, and they aren't coming back. Sears and J. C. Penney seem stuck in time, and relative to their competition, there are at least three reasons they will continue to fail.

Nostalgia only goes so far
To be fair, I used to be one of those kids looking at the Sears catalog. My family used to make those trips to J. C. Penney for new school clothes. However, in the last few years, we haven't stepped foot in a J. C. Penney, and Sears is a rare stop indeed.

The problem with both companies is they are largely tied to enclosed shopping malls for their primary locations. The mall is no longer the central hangout that it used to be; the most common comment about mall-based stores seems to be, "When did that close?"

In fact, in a recent USA Today article, Sears and J. C. Penney were listed as two of the nine retailers closing the most stores. The mistakes that both companies have made are almost carbon copies of each other.

The truth is, Sears and J. C. Penney are both trying to do what other companies are just better at. Macy's (NYSE: M  ) is better at focusing on high-end clientele and has the results to show for it. Target and Kohl's are better at selling clothes, and discount retailers like TJ Maxx, Marshalls, and Ross Stores, have better deals.

These are not discount retailers and need to stop pretending
In the last few years, J. C. Penney famously tried to rebrand itself as a discount- priced retailer and failed miserably. After multiple quarters of 20%+ comparable-store sales declines, the company finally recovered somewhat with a 2% increase in same-store sales in the last three months.

Sears hasn't been so lucky, reporting same-store sales declines of 6% to 8% between Sears domestic and Sears Canada and a 5% decline at Kmart. By contrast, Macy's reported a 1.4% increase in same-store sales in the current quarter.

The first challenge for both Sears and J. C. Penney is rebranding themselves as higher-end retailers. In fact, Macy's should be their blueprint for success, as the company carries a gross margin of more than 40% compared to a 28% margin at Penney's and a 24% margin at Sears. Continuing to try and compete at the lower end will only lead to more pain for both stores.

So much money!
The second issue facing both Sears and Penney's is the companies spend too much on selling, general, and administrative expenses relative to their service levels and layout. Macy's spent 25% of revenue on SG&A, but in a store with a 40% gross margin and a reputation for quality service this makes sense.

Sears, on the other hand, has centralized checkout islands and a much lower gross margin. But it spent almost 26% on SG&A at Sears domestic stores and more than 29% on SG&A at Sears Canada. With less of a reputation for service, and lower margins, Sears simply can't afford this type of SG&A expense.

J.C. Penney is suffering in a similar way. The company's SG&A percentage was almost 27% in the current quarter, and again this is far too high. Penney's locations and selection do not scream high-end quality, yet the company is spending more on SG&A than its peers.

Time to face reality
The third problem facing Sears and Penney's is both companies are taking on debt as though their results deserve additional investment. In the last year, J. C. Penney's long-term debt net of cash increased by 73%. In a similar way, Sears' long-term debt increased by more than 35%. As you might have guessed, the more successful Macy's cut its net long-term debt by 10% in the last year.

In the end, it is simple. Sears and J. C. Penney both have gross margins that suggest the wrong pricing strategy. Compounding this error, both companies are spending too much on SG&A and meanwhile are taking on debt.

Sears is divesting businesses and reprioritizing, and J. C. Penney is getting back to its old sales. But if neither company faces these significant problems, it won't matter. I think that investors should stay away from both companies until they realize the error of their ways.

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Read/Post Comments (6) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 01, 2014, at 8:47 PM, Hallwitch wrote:

    It doesn't matter where Sears is located, if they keep the same help they can't make it.

    If you buy a Craftsman sander today you won't be able to get sand paper for it. I returned a tool that was broken and the clerk wrote used on it and put it on the clearance shelf.

    So long Sears, I'll be at Home Depot or Lowes.

  • Report this Comment On April 02, 2014, at 5:32 AM, thebumpkin wrote:

    yournewssux , If you will notice this is a Motley Fool article. I would think that the author of this article has carefully researched the information provided in this article. These folks are not writing news articles. They write articles meant to inform investors. You should think carefully before hitting post your comment.

  • Report this Comment On April 02, 2014, at 8:24 AM, salply34528 wrote:

    IF YOU LITEN TO MOTLEY FOOL you are a FOOL. They were telling everyone what a great company WTW was and what a great buy at $60

    look at it now at $20

    If you listen to these idiots you will lose yout shirt

  • Report this Comment On April 02, 2014, at 9:14 AM, seaguy wrote:

    JC Penney has a chance but Sears the way they are going has little chance they continue to close stores and the ones left open are not fixed up, they are shabby, run down and out of date. Turning off shoppers.

  • Report this Comment On April 03, 2014, at 3:23 PM, FlyBoyRDJ wrote:

    Both Sears and JC Penney's were foolish to abandon their catalogs in favor of the stores. The catalogs could easily have been morphed into online shopping experiences at far less cost than running the brick and mortar stores. Complete lack of vision there. However, these companies are also running into the Walmartization of goods in general. The variety and quality of goods that were available in these stores one or two decades ago is long gone, as their manufacturers have closed shop or gone overseas. Now most of the merchandise available for sale by these companies is the same few models/styles sold at many other places, often for less. Even the venerable Craftsman tool brand has been mostly replaced now by cheap imports and knock-offs. Sad.

  • Report this Comment On April 18, 2014, at 7:24 AM, Matt8265 wrote:

    The reason SG&A are high at JCP is that sales has dropped by 30-40%. As the gross sales increase, the % will decline. The reason the debt is high, and it is, is to maintain liquidity during the restructure which may, or may not work.

    I think JCP will prove that it is doing just fine and while taking 2-3 years to fully recover, will do just that. Sears I'm afraid, is done.

    Catalogs ... I've heard this a lot and think it would be a GREAT idea for JCP to do. This is " old school " but the idea seems to resonate in many places.

    Mike U. is doing a great job in the turnaround and should be commended. 12 months on the job and the store is firing on 7 cylinders up from 3.

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