How Department Stores Came Back into Fashion

With Lady Gaga blaring overhead, Felicia Terry and Susanna Chung check out a display of dressy, short-sleeve tops in a Manhattan store. A few feet away, a black chandelier hangs over rows of skinny jeans and aviator sunglasses. A pair of chic peep-toe sandals selling for more than a C-note floats nearby on its own shelf. The twentysomethings aren't trolling for new styles at some hip Soho boutique but at one of America's most venerable merchants, J.C. Penney (JCP). "If this was the old J.C. Penney," Chung says, "we would have just walked by."

U.S. department stores, widely regarded as endangered 10 years ago, are staging an unlikely revival. Along with high-end icons like Saks (SKS) and Bloomingdale's, middle-market players such as Penney, Macy's (M), Dillard's (DDS), and Kohl's lately have been luring shoppers with exclusive, trendy items that appeal to Gen Y. Once-stodgy department stores are a "credible destination for fashion," says Brian Sozzi, an analyst at Wall Street Strategies. Financial results at department stores also are outpacing those at many specialty retailers such as Gap (GPS) and American Eagle Outfitters (AEO). In February, sales at department stores open at least a year rose 5.7 percent, versus a 3.2 percent gain for apparel stores, according to the International Council of Shopping Centers. That trend has prevailed for three quarters.