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With J.C. Penney Closing Stores, Which Rising Stars Could Fill the Void?

By Robert Hanley – Mar 23, 2014 at 10:00AM

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The tenant mix at the regional malls continues to change as big-box retailers like J.C. Penney and Sears Holdings increasingly look to shrink their national store bases. Can investors find investment opportunities among the new tenants?

Regional mall owner Pennsylvania REIT announced a repositioning strategy for its Exton Square Mall in mid-January after anchor tenant J.C. Penney (JCPN.Q) disclosed its intention to close its store there. This is just one of a host of locations that the retailer plans to close.  The financial troubles of age-old big-box retailers like J.C. Penney and Sears Holdings have generally led to reduced operating footprints for these companies, which has left mall owners with unwelcome vacant space.  Fortunately, a new crop of retail juggernauts have risen up to take the place of the fading giants. So, what retail investment ideas can an investor glean from this particular redevelopment action?

Out with the old
J.C. Penney has certainly been wading in troubled waters recently, though that fact shouldn't be news to even a casual observer of newspaper headlines. The company's attempt to mimic retail kingpin Macy's through a more upscale product selection and an everyday low price strategy was poorly received by its value-conscious customers, which led to a sharp sales decline and a big operating loss in 2012.  Compounding its troubles, J.C. Penney tried to poach home fashion designer Martha Stewart from its larger competitor's clutches, a move that landed all parties involved in court and which will likely lead to a large financial cost for J.C. Penney despite its recent moves to unwind the relationship.

In 2013, J.C. Penney tried to move away from the precipice, largely through financing activities that included sizable issuances of debt and equity.  The company also reverted back to a focus on private-label brands and promotional marketing which seemed to staunch its customer losses, which was evidenced by a slight pickup in comparable-store sales in its latest fiscal quarter.  However, the cost of J.C. Penney's business "un-makeover" was prohibitively expensive, and as a result the company ended up in a weakened financial position that will likely mean further reductions of its presence in the nation's malls.

In with the new
Of course, J.C. Penney's exit from Exton Square stands in stark contrast to the store openings being engineered by financially strong and growing retail franchises like Starbucks (SBUX 0.33%).  Despite a massive operating footprint of roughly 20,000 stores in 63 countries, Starbucks remains in expansion mode and this is especially true in the heavily populated Asia-Pacific region where it added nearly 600 stores in its latest fiscal year. The company also appears primed to gain additional traction from its 2011 acquisition of tea retailer Teavana as it continues to expand the unit's store network into new markets like Exton Square's Pennsylvania location.

In its latest fiscal year, Starbucks reported solid financial results which included a 12% top-line gain that was aided by the continuation of a favorable comparable-store sales performance. More importantly, the company took advantage of lower average coffee prices to generate higher operating profitability during the period, as it saw a 23.1% increase in its adjusted operating income. The net result for Starbucks was higher cash flow that will easily fund its growth initiatives, which include a larger mall-based presence for its Teavana unit.

Also entering the scene at Exton Square is Chico's FAS (CHS -0.94%), a diversified women's retailer that has recently added both a Chico's and a White House/Black Market store to the mall's tenant portfolio. The White House/Black Market brand has been a growth engine for Chico's over the past few years which has helped the company expand its overall store base by roughly one-quarter and broadened its appeal to a younger, more affluent demographic.

To be sure, 2013 was not Chico's best year as it succumbed to weak industry fundamentals, which was evidenced by a 1.8% decline in its comparable-store sales that ended a four-year streak of comparable-store sales gains above 7%.  Nevertheless, the company's increasingly diverse brands across apparel categories and price points allowed it to remain profitable and debt-free during a challenging year and also provided the company with capital to continue growing its store base at a time when other retailers are retrenching.

The bottom line
Pennsylvania REIT's Exton Square mall repositioning is a pretty good snapshot of the changes in retail which have pitted shrinking old-time big-box retailers against growing specialty retailers which have strong brands. Since larger mall footprints for companies are usually precursors of higher sales and profits, Starbucks and Chico's FAS are definitely stocks that investors should watch.

Robert Hanley has no position in any stocks mentioned. The Motley Fool recommends Starbucks. The Motley Fool owns shares of Starbucks. 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.

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