J.C. Penney (JCPN.Q) and Sears Holdings (SHLDQ) have long competed for roughly the same customers. That's a sort of American tradition, where most success stories seem to lead to the emergence of an obvious rivalry. Coca-Cola has PepsiCo, Home Depot has Lowe's, and McDonald's has Burger King. Those are rivalries that have endured, where the market has proved big enough for two main players.
However, in other areas, the market has taken one-time rivals and created winners and losers. Best Buy, for example, survived when longtime rival Circuit City could not and Barnes & Noble still exists while Borders Books is no more.
J.C. Penney and Sears Holdings, which owns Sears and Kmart, seem headed for the second kind of outcome, where only one survives, and that demise benefits the other.
While both chains have problems, J.C. Penney has been slowly, and with a lot of bumps in the road, putting itself back on track. Sears has a plan, an outspoken CEO, and some assets yet to sell, but little that it's done is working to bring customers back.
J.C. Penney has added appliances and home services specifically in markets Sears has left. Image source: J.C. Penney.
Why J.C. Penney will make it
Investors got nervous earlier this month when J.C. Penney reported that comparable sales were down 3.5% for the quarter. That's bad news, but it's not the entire story.
J.C. Penney has made considerable progress toward materially changing its business. The company has enacted growth initiatives, including adding store-within-a-store Sephora locations in many of its stores, bringing appliance showrooms to another 100 locations, and improving as well as rebranding its in-store salons.
"Even in the face of a difficult top line for the first quarter, our new growth initiatives delivered another quarter of strong performance and positive comps, particularly appliances, in-home custom windows, mattresses, furniture, Sephora, Salon, Activewear and Fine Jewelry," said CEO Marvin Ellision in the chain's Q1 earnings call, which was transcribed by Seeking Alpha (registration required). "All of these businesses are expected to deliver even greater benefits for the remainder of 2017."
J.C. Penney has also been shifting its apparel strategy, which Ellison acknowledged as "all important" while admitting that the chain struggled in that area in Q1. He did point out that new initiatives in its "Now Trending" items, as well as in active apparel and the dress business, have performed well.
"Improvements in these apparel categories bode well for the balance of 2017, as these items become a much larger piece of our business moving forward," he said.
In addition to taking meaningful steps to transform its stores into multifaceted destinations with more appealing merchandise, J.C. Penney is also on track to pay down $520 million in debt in fiscal 2017. Along with that, while the chain reported a net loss of $180 million, or $0.58 per share, in Q1, that number is misleading because it includes a number of one-time charges.
The loss includes $220 million related to its plan to close nearly 140 stores. Without that, and other one-time expenses, the company would have recorded a $0.06-per-share profit, compared with a net loss of $97 million, or $0.32 per share, last year.
Why Sears is on its way out
The difference between J.C. Penney and Sears is one of execution. Both companies are struggling, but J.C. Penney has embarked on a plan to make its stores viable in the current market, while Sears has largely bet on financial maneuvering and an online operation called "Shop Your Way" that has little chance of becoming any sort of significant player in the digital space.
While J.C. Penney has experimented with changes to its stores such as adding appliances, which it now offers in more than half of its stores, Sears has mostly tried to cut its way to survival. That can keep the company afloat in the short term -- around two more years, if you look at debt versus assets.
Sears has been closing stores, selling assets, and leveraging its real estate. What it hasn't been doing is making major changes to its business, aside from the pie-in-the-sky idea that Shop Your Way, a business that it doesn't break out revenue for in its quarterly reports, will become a revenue driver.
CEO Eddie Lampert, who recently took major issue with "critics" who believe the company is headed to bankruptcy, commented on the company's progress in an April press release.
"Consistent with our ongoing strategy of focusing on our Best Stores, Best Categories, and Best Members, we will continue to take difficult yet necessary actions," he said. "As we sharpen our focus on profitable areas of our business, we will also continue to closely evaluate the longer-term viability of stores where a clear path to return to profitability is not in sight."
Those are the sort of vague promises Lampert has become known for. The CEO clearly understands how to manipulate the company's assets and stretch out its runway. The problem is that selling off assets for survival only makes sense if you have a viable plan to return to profitability.
Sears' plan appears to be that at some point it will be small enough, with a low enough cost structure to make money. That may be true, but that's not really survival; it's a managed fire sale, where a shadow of the former brand may remain.
Sears' loss is J.C. Penney's gain
J.C. Penney has already profited from Sears' woes. The company decided to move back into appliances because Sears was leaving many markets. Ellison's company targeted markets its rival had left as it added appliance showrooms. It's doing the same as it tests six different home services, including heating and cooling systems, bathroom remodeling, quick ship, and installed blinds, working with partners in markets Sears has abandoned.
Clearly, J.C. Penney sees opportunity in the customers its rival has stopped being able to serve. Those opportunities will increase as Sears closes or shrinks more stores, which should bolster J.C. Penney's turnaround efforts.
This is a case where the changing retail market means that many communities simply can't support a Sears or Kmart and a J.C. Penney. The loss of one, however, should help the other, and in the end J.C. Penney may be battered, changed, and not quite what it once was, but it at least has a path toward survival that's being aided by Sears' failure.
