The Competitive Advantage of Square Footage

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Not many things have gone right for J.C. Penney (NYSE: JCP) since the announcement of its glorified come back plans about a year ago. In their most recent quarter JCP posted a disheartening EPS loss of 93 cents, revenues slid 27% and comp sales freed up a Sunday to land a complimentary 26% haircut. This type of performance is horrifying by any means, but especially disconcerting for a company who is expected to be getting back on its feet by now. Plausible excuses are running short for Penney’s largest endorser Bill Ackman and its CEO Ron Johnson, but the duo still claims that there’s one piece of evidence right there in the store that proves their strategy, and it’s measured in square feet.

Most, if not all of us at least somewhat interested in the story behind J.C. Penney’s turnaround have perused Mr. Ackman’s presentation on the plan and know that one of the key components of his thesis was the value of the store’s real estate in comparison to its sales. In recent quarters, a relatable triad of competitors in this space were operating along the following parameters for respective sales/sqft and SGA expenses/sqft: JCP $150/sqft and $45/sqft; Kohl’s (NYSE: KSS) $190/sqft and $43/sqft; Macy’s (NYSE: M) $170/sqft and $54/sqft. Seeing as how JCP owns about 50% of their square footage outright and the other half is reasonably leased, there should be no reason why its value couldn’t be leveraged in conjunction with the expected reduction of $900 million to SGA expenses, according to the plan. If implemented ideally, this would return Penney’s sales/sqft back to the peak 2007 level of $177 and at least bring the company back into the same league as their competition.   

Then the euphoric optimism sets in. Presuming that Penney first effectively fragments into an array of specialty stores, the theory then goes that they could begin matching the sales quality of other established specialty stores such as GAP, American Eagle or Aeropostale. These companies produced sales/sqft varying from $340-$560 in 2011, which would infer a potential 100%-200% increase in sales/sqft for Penney. It’s tough to compare this hypothetical situation to those of these other retailers right now because we have yet to see the consumer sentiment towards this new “store in a store” concept of retail, but Penneys does claim one relevant example to draw on -- Its Sephora cosmetic stores that operate under this concept continue to reel in young consumers who are willing to pay premium prices. Sephora’s growing popularity continues to influence expansion as 38 new shops went up last quarter, bringing the total count to 386. Penneys clings to this reference as inspiration, but there could be a very important distinction to make between the quality of products that Sephora has to offer in comparison to the once littered and degraded products that J.C. Penney has now decided to organize and make presentable.               

Whether this is all fantasy or reality still remains unanswered, but Penney has interestingly stated that the new shops’ 11% of real estate is averaging sales that are more than double those of the rest of the store. This will be an interesting figure to keep an eye on as the store transforms, but if the pace doesn’t pick up then father time could spoil any surprises as atrocious quarters continue to pound the stock and wither away at whatever hopes are left in the faithful, all while the company burns through its financing. If Penney’s value per square foot evolves in the direction of any of these positive scenarios, hope could be replenished and a heavy burden of uncertainty lifted at a much needed time.   


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