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J.C. Penney Is the King of the Class-B Mall -- And That's OK

By Adam Levine-Weinberg - Feb 1, 2018 at 9:40PM

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J.C. Penney is one of the few department store chains that is still posting solid sales results in mid-tier malls.

In recent years, there has been a bifurcation of malls between Class A properties -- those that have the highest sales per square foot -- and those rated B or C by Green Street Advisors. Despite the supposed death of the mall, Class A properties remain vibrant retail hubs, with stable or rising sales per square foot. As a result, there is ample demand for space at these malls.

By contrast, B- and C-rated malls are enduring traffic and sales declines. When anchor stores close at these properties, mall owners often have trouble finding replacement tenants. This creates a vicious cycle: Who wants to go to a mall with lots of empty storefronts?

Compared to rivals like Macy's (M 9.09%), J.C. Penney (JCPN.Q) is heavily exposed to these lower-performing malls. Despite this inherent challenge, it has posted surprisingly solid comp sales results in recent years. This suggests that it has a competitive advantage in serving mid-tier malls -- which could allow it to sell off some of its better stores to pay down debt.

The exterior of a J.C. Penney store.

J.C. Penney has a lot of stores in B-rated malls (and even C-rated malls). Image source: J.C. Penney.

Better sales trends with weaker stores

Two years ago, an activist hedge fund that invested in Macy's published a detailed analysis of the company's real estate. At the time, more than 40% of Macy's owned and ground-leased mall-based stores were located in A-rated malls. (This concentration has probably increased due to Macy's store closures over the past two years.) That's a big reason -- along with the company's urban flagship stores -- why Macy's real estate may be worth more than its entire market value.

J.C. Penney's store base is spread more broadly across the spectrum of malls. As of early 2015, only a quarter of J.C. Penney's nearly 700 mall-based stores were in A-rated malls. Half were in B malls, with the rest in even worse locations.

One might expect that Macy's would be posting stronger sales results than J.C. Penney, due to its superior real estate. However, that hasn't been the case. Macy's posted a 2.5% comp sales decline in fiscal year 2015, followed by a 2.9% decrease in 2016 and a 3.6% fall in the first three quarters of fiscal years 2017. Meanwhile, J.C. Penney delivered 4.5% comp sales growth in fiscal year 2015, flat comp sales in 2016, and a 1% decline for the first three quarters of fiscal year 2017.

J.C. Penney's outperformance continued during the recent holiday season. It achieved a 3.4% comp sales increase for the combined November to December period, compared to 1.1% comp sales growth at Macy's. While J.C. Penney may have a lot of stores in weaker malls, it doesn't seem to be suffering greatly from the traffic declines there.

What's the best use of a store?

In recent years, Macy's has been more aggressive about closing stores in low-performing malls than J.C. Penney. (While J.C. Penney closed almost 140 stores last year, many of these were small, off-mall locations in rural areas.) Macy's hasn't been able to overcome the weak trends affecting these malls.

The exterior of a vacant former Macy's store.

Macy's has aggressively closed stores in weaker malls recently. Image source: Author.

As a result, while Macy's has lots of great real estate that could be sold for a hefty price, nearly all of those stores are vital to the company's long-term business plans. Thus, while Macy's has downsized some of its 150 best-performing stores, it hasn't closed/sold any of them outright.

By contrast, the core of J.C. Penney's store base is made up of properties that wouldn't be worth much to anyone else. This means that there isn't much of an opportunity cost to operating stores that the company owns. For leased stores, J.C. Penney may be able to pressure landlords for rent reductions.

As for J.C. Penney's stores in A-rated malls, they aren't strategically vital in the same way as Macy's stores in the same malls. In some sense, it's not very surprising. The best malls tend to cater to higher-income consumers. That isn't J.C. Penney's target market. This potentially gives the company opportunities to sell off valuable real estate that isn't critical to its business.

Getting ready to follow this path?

Back in November, J.C. Penney CFO Jeff Davis noted that the company was likely to sell a store lease during the fourth quarter for about $50 million. It appears that this deal covered its store at Westfield Garden State Plaza in Paramus, New Jersey. Last week, J.C. Penney confirmed that the Paramus location will close in early March.

In addition to having Macy's and J.C. Penney stores, Garden State Plaza also has Nordstrom and Neiman Marcus as anchors. It's not surprising that there are other tenants willing to pay vastly more than J.C. Penney for space in an upscale mall like this.

For J.C. Penney, the $50 million it will receive is a meaningful sum. The company is working hard to reduce its debt load, which stood at about $4.3 billion as of late October, including $190 million that matures in February. The proceeds from selling this store will help J.C. Penney pay down this upcoming maturity, reducing its future interest expense.

In the coming years, J.C. Penney may find further opportunities to sell some of its best-located stores. While these stores are undoubtedly profitable, getting a lump sum payment to close them might be an attractive option. After all, J.C. Penney's stores in B-rated malls seem to be doing just fine -- and J.C. Penney needs to continue reducing its debt load.

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J. C. Penney Company, Inc.
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