J.C. Penney Revival Hinges on Avoiding Holiday Price War

Now that J.C. Penney Co. (JCP) Chief Executive Officer Mike Ullman has slowed the sales decline and amassed enough cash to fund two years of operations, he faces his biggest challenge since returning as CEO: a holiday season marked by price wars and penny-pinching consumers.

Analysts predict that U.S. retailers will discount heavily as they compete for shoppers concerned by joblessness and budget battles in Washington. While J.C. Penney has shored up its operations and finances, Macy’s Inc. (M) and Kohl’s Corp. (KSS) can better afford to cut prices to drive traffic. If Ullman is forced to join the price war, he risks hurting profitability and burning cash at a faster than projected rate.

At the same time, Americans are buying less apparel, which makes up more than half of J.C. Penney’s sales, as they shift their dollars into such consumer durables as cars and appliances. If that trend persists, retailers will really pour on the discounts, making Ullman’s task even more challenging.

“It’s going to be hard,” Poonam Goyal, a Bloomberg Industries analyst, said in an interview. “Holiday isn’t going to be great for anyone, except maybe for off-price retailers.”

Ullman, who returned for his second stint as J.C. Penney’s CEO in April, has been working to undo a failed attempt by predecessor Ron Johnson to make the Plano, Texas-based department-store chain into a destination for younger and richer shoppers. While he has had to continue paying for expensive renovations Johnson ordered, Ullman has reinstituted sales events and brought back popular private-label brands that Johnson nixed.

Sales Rebound

Those plans helped slow the drop in sales at stores open at least 12 months to 4 percent in the month through Oct. 5, J.C. Penney said. Sales rose in women’s apparel, the chain’s largest business, the company said, without saying how much. The progress hasn’t helped the shares, which through yesterday had declined 60 percent this year compared with a 19 percent gain for the Standard & Poor’s 500 Index. Fifteen analysts recommend holding the shares, eight recommend selling them and three recommend buying them, according to data compiled by Bloomberg.

Ullman has aggressively shored up J.C. Penney’s finances. Early on, he drew $850 million from a revolving credit line, then arranged a loan commitment from Goldman Sachs Group Inc. that provided the company with $2.25 billion in cash. Last month, he sold 84 million shares, generating about $785 million after fees. The share offering came about a month after J.C. Penney said its forecast for year-end liquidity didn’t assume the need to raise more cash this year.

War Chest

The company now says it will end the year with more than $2 billion in liquidity. Assuming its losses don’t accelerate, the war chest should last the company through 2015, said Liz Dunn, an analyst at Macquarie Group in New York. Significant improvement would give the chain more time to complete the turnaround and it “seems like they are on the right track,” she said.

Still, if the holiday season doesn’t pan out as expected, the chain may use most of the cash it just raised and be back in the same dilemma in a year, said Michael Binetti, an analyst at UBS AG in New York, who recommends selling the shares.

A lackluster back-to-school shopping period raised concerns that consumers will curb spending in the fourth quarter. Several apparel retailers are struggling and may offer deeper discounts earlier than usual to attract shoppers. Analysts project that revenue at seven of the nine public companies in Bloomberg U.S. Department Store Index will either drop or be basically unchanged.

Margin Crimp

An early race to the bottom on prices may crimp J.C. Penney’s much-needed gains in gross margin, or the percentage of sales left after costs of goods sold.

Analysts project J.C. Penney’s gross margin will expand to 31.3 percent in the fourth quarter from 24 percent a year earlier, when Johnson’s failed strategy forced J.C. Penney to massively discount merchandise to grab any sales it could. The average gross margin in the Department Store Index was 36 percent during that period.

The good news for Ullman is that the company will consume less cash as the retailer winds down Johnson’s attempt to turn J.C. Penney’s stores into collections of branded boutiques. Capital expenditures will be $300 million in 2014, the company said on Aug. 20. That compares with analysts’ estimates for $951.7 million this year.

The company also can pull back on rebuilding inventory depleted under Johnson because his team incorrectly allocated goods to stores based on square footage rather than a given store’s sales volume.

Ullman’s decision to bring back several private-label brands axed under Johnson should help him restrain discounts because house brands can’t be found elsewhere and hence are impossible to comparison shop. Private-label merchandise generates more than half of the company’s sales.

J.C. Penney’s success this holiday will depend largely on whether “the consumer environment remains steady to better, and doesn’t worsen,” Goyal said. “As long as that happens and they continue to use promotions to drive traffic and get the right merchandise in stores, they should be OK.”

To contact the reporter on this story: Matt Townsend in New York at mtownsend9@bloomberg.net

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

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