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

Until these companies come back to reality, investors should probably stay away.

Apr 1, 2014 at 6:30PM

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.

2 stocks changing the retail world
To learn about two retailers with especially good prospects, take a look at The Motley Fool's special free report: "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail." In it, you'll see how these two cash kings are able to consistently outperform and how they're planning to ride the waves of retail's changing tide. You can access it by clicking here.

Chad Henage has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information