J.C. Penney (NYSE:JCP) was rated a sell the other day by Citigroup analysts, who highlighted five reasons to show that there was little to no help for the retailer.
While they pointed out it's difficult "to come back from self-inflicted wounds" and it still needs to spend a ton of money before it can hope to become free cash flow positive, the Wall Street pros ignored an even more compelling, immediate threat: fast-fashion powerhouse H&M (NASDAQOTH:HNNMY).
No, it's not because J.C. Penney is also heading down the disposable fashion runway like too many other retailers who think they need to emulate the likes of H&M, Zara, and Forever 21 to effectively compete for consumer dollars (though it seems to me a big fashion faux pas to do so).
Rather, it's because H&M just dove headfirst into the beauty care pool. If the fast-fashion house ends up doing for makeup what it did for clothes, J.C. Penney could be in a lot of trouble.
The department store operator has managed to confound analysts like those at Citi for years as it's worked to recover from those self-inflicted wounds. Having to undo the many radical changes ex-CEO Ron Johnson implemented that set the retailer back and plunged it dangerously close to bankruptcy is consuming all of its time -- and cash.
J.C. Penney has been pretty successful thus far, which is why Wall Street is often left scratching its head, and though the path forward has had quite a few bumps, the retailer is in a much better place financially than it was just two years ago. So far, this year its stock has soared 45% higher.
A large part of the department store's success, however, has been because of beauty care supplier Sephora, which operates store-in-store boutiques in more than half of J.C. Penney's 1,020 stores, with more to come in the future.
Earlier this year, former CEO Mike Ullman said Sephora was "one of the anchors of our center core growth strategy" that focuses on high-margin items in handbags, accessories, sunglasses, fashion jewelry, and beauty care.
The makeup retailer is key to J.C. Penney's long-term success because it drives traffic and sales at the department stores they're located in. Although it's found the center core strategy currently generates just a small percentage of cross-shopping opportunities (but one it feels it can effectively exploit for much greater growth in the future), Sephora is already doing that for the chain, delivering deliver double-digit growth and generating significant customer loyalty.
The retailer doesn't break out dollar amounts when discussing Sephora's contributions, but does tend to describe quarterly sales from the boutiques with superlatives and words like "great" and "outstanding."
Sephora owner LVMH Moet Hennessy Louis Vuitton (NASDAQOTH:LVMHF) reported that first-half segment revenues grew 21% year over year primarily as a result of the makeup artist, while it also gained market share.
Until the appearance of Sephora and rival outlet Ulta Salon, the market for makeup was largely split between drugstores like CVS Health and Walgreens and department store counters featuring sales personnel from the likes of Clinique, Clarins, and Lancome. The Sephora experience is different, and has resonated well with consumers.
That's why H&M could be a threat. Calling what it's undertaking "fashion for the face," the fast-fashion clothing house launched last month a 700-product beauty care line across makeup, skincare, and hair care that will appear in some 900 stores worldwide.
The lure is the makeup would be priced affordably, though there is risk involved in pursuing such a venture. Price isn't always of primary importance; natural ingredients is the growing trend, with one survey finding that more than half of all women believe "it is important their skin care products are all-natural."
But H&M does have a strong brand affinity with consumers. In its third-quarter earnings report, it said sales are up 22% year to date, generating a 12% increase in profits over the first nine months of the year.
If H&M can put its best face forward on makeup as it did for fashion, Sephora could see its leadership position undermining the turnaround J.C. Penney has been making. Wall Street analysts may have found the right rating but for the wrong reasons.
Rich Duprey owns shares of J.C. Penney Company. The Motley Fool recommends CVS Health and Ulta Salon, Cosmetics & Fragrance. 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.