J.C. Penney Falls as CEO’s Store Tour Gets Tepid Response

J.C. Penney Co. (JCP) dropped the most in four months after Chief Executive Officer Ron Johnson’s showcase of the stores’ new layout failed to inspire confidence in his remake of the 110-year-old retailer.

The shares fell 11 percent to $25.83 at the close in New York, the biggest one-day drop since May 16. The Plano, Texas- based company was the biggest decliner on the Standard & Poor’s 500 Index today and has lost 27 percent this year.

Johnson, the former Apple Inc. (AAPL) retail chief who joined the retailer last year, took 300 analysts on a tour of a 30,000- square-foot prototype yesterday, located on the third floor of a J.C. Penney store in a Dallas mall. He aimed to show how he is working to transform most of the company’s stores into a collection of 100 branded shops and gathering areas, a linchpin of his strategy that he says will revive sales.

“Some of the air needs to come out of the proverbial bubble as reality sets in that although JCP is taking steps in the right direction, the road to recovery is still a few years away,” Charles Grom, an analyst at Deutsche Bank AG in New York with a hold rating on the shares, wrote in a note yesterday. While Johnson said he wants to keep current shoppers, his plan to ultimately move to slightly younger or higher-income customers “gives us some concern,” Grom wrote.

Sales Declining

While Johnson said results at the 12 boutiques installed at almost 700 of its stores are beating comparable sales of other merchandise by 20 percent, he said it has been a “tough last two weeks,” and reiterated his year of transformation still has 13 weeks and two days left. J.C. Penney’s comparable-store sales fell 22 percent in the quarter ended July 28.

Even though the mock-up store was impressive, the company will be challenged to replicate it in 700 stores and it’s uncertain when sales will improve, Paul Lejuez, an analyst at Nomura Securities International Inc. in New York, said today in a note to clients.

“We want to believe this can work, and longer term, we think it will,” said Lejuez, who rates the shares neutral, the equivalent of a hold. “But this has been, and will likely continue to be a roller coaster ride with many ups and downs.”

It’s an unfavorable reaction to an event Johnson held to convince long-term investors to buy into his vision.

Mini Shops

“For a long-term investor to understand what we’re trying to do, there’s nothing like seeing to understand,” Johnson said yesterday to the group of analysts, which also included activist investor Bill Ackman, who backs his strategy. The prototype began taking shape in May, when his management team started “to move from an idea into an art project,” he said.

Johnson aims to create a new type of retailer called a “specialty department store,” with about as many mini-shops as most malls have, and has already introduced boutiques for Levi Strauss & Co. and Izod products. The company plans to widen aisles by five feet to 15 feet, and install couches, Lego-laden tables and computer browsing areas in the extra space.

That part of the store, or the Street, as Johnson calls it, is “the game-changer,” Ben Fay, head of real estate, store design and development, said yesterday as analysts and investors wandered the space, eating gelato and sampling coffee from potential dining spots in the store.

‘Great Vision’

“It certainly highlights they’ve got a great vision,” Erika Maschmeyer, an analyst at Robert W. Baird & Co., said yesterday after the tour. “They still have 1,100 physical stores where it’ll take time to implement these changes,” said Maschmeyer, who has a neutral rating on the stock. Investors “shouldn’t get overly excited,” she said.

The company’s sales fell more than 20 percent in the first and second quarters as Johnson implemented store layout changes and switched to a system of everyday low prices to cut back on promotions, moves that alienated or confused some customers.

While analysts project sales declines of at least 11 percent in the next two quarters, according to data compiled by Bloomberg, investors such as Ackman’s Pershing Square Capital Management LP are supporting Johnson’s vision. Johnson and Ackman, the biggest shareholder with 18 percent, chatted throughout the day.

He cited Caribou Coffee Co. (CBOU) as an example of a snack-vendor that may pepper the wider aisles of the new stores and give families another reason to spend time there.

New Vendors

The prototype also had shops in place for newly announced vendors such as Walt Disney Co. (DIS) and Giggle, for baby goods. J.C. Penney distributed $25 gift cards to the group and encouraged them to shop, transporting interested analysts afterward to an updated store at the nearby Stonebriar Centre Mall in Frisco, Texas.

“The idea of shops is especially enticing to start-ups and international potential partners looking for an expedited and inexpensive way to gain access and scale in the U.S.,” Deborah Weinswig, a Citigroup Inc. analyst, wrote in a note yesterday. Weinswig, who is top-ranked by Institutional Investor, said the stores “will offer a shopping experience unlike any other in apparel retailing,” and reiterated her buy rating.

The new layout will affect about 700 of J.C. Penney’s bigger shops. The company will detail plans for its 400 smaller stores “in the near future,” Johnson said last month.

The company plans to have 40 mini-shops in each of the bigger stores next year, and is mostly putting construction on hold until after the holiday shopping season, Johnson said. It will have mobile checkouts throughout stores beginning Feb. 1.

Fashion Shows

Specialty stores account for a greater proportion of U.S. retail sales than department stores, a shift from the 1950s and 1960s that Johnson is looking to capitalize on with the new layout, said Robin Lewis, a New York-based retail consultant who toured the prototype earlier this month.

The boutique-like atmosphere and events, such as fashion shows, classes and dining spots, will encourage customers to spend more time at J.C. Penney and spend more money, Lewis said in a telephone interview. He said the stores may make $350 per square foot from about $135 each they currently make.

Through yesterday, J.C. Penney’s stock had gained more than 20 percent since Aug. 10, when Johnson said his overhaul of the department-store chain was “on track.” On that day the shares rose the most in six months even though it reported a 23 percent decline in sales to $3.02 billion, the lowest quarterly sales since at least 1989, according to data compiled by Bloomberg.

Bonds Fell

The company’s bonds fell today. J.C. Penney’s $400 million of 5.65 percent senior unsecured notes due in June 2020 declined 2.6 cents to 91.5 cents on the dollar to yield 7.1 percent at 3:06 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Earlier this year, Moody’s Investors Service cut the company’s credit rating to Ba3, three levels below investment- grade and Standard & Poor’s downgraded it to B+, one grade lower. The average B rated bond yields 6.86 percent, according to Bank of America Merrill Lynch index data.

Yesterday’s call “did not sway our belief that the near- term story at JCP will continue to be defined by poor comp sales and extremely weak financial performance -- even relative to recession-era holiday seasons,” James Goldstein, an analyst at CreditSights Inc. in New York, wrote in a note yesterday.

To contact the reporter on this story: Sapna Maheshwari in New York at sapnam@bloomberg.net

To contact the editor responsible for this story: Robin Ajello at rajello@bloomberg.net

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