Sizing Up the Players in This Love(less) Triangle

By Robert Hanley - March 19, 2013 | Tickers: JCP, M, MSO | 0 Comments

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Macy’s (NYSE: M) and J.C. Penney (NYSE: JCP) are used to playing rough in the retail business, but their rivalry has recently included a trip to the courts. Macy’s sued J.C. Penney in January 2012 over the latter’s agreement with Martha Stewart Living (NYSE: MSO) to add Martha Stewart-inspired boutiques to a portion of J.C. Penney’s store base. Macy’s claims its 2007 agreement with Martha Stewart Living provides for the exclusive distribution of a range of products. With the outcome of the trial up in the air, let’s take a look at the players.

J.C. Penney

Despite a rich history that dates back to 1902, J.C. Penney is struggling to find its way to profits in the digital age. New CEO Ron Johnson, a former Apple retail star, has brought a new product strategy to J.C. Penney, as well as creating branded, in-store boutiques that include Sephora jewelry and Joe Fresh apparel shops. However, the early results have been poor, with big declines in comparable store sales.

In FY2012, J.C. Penney reported weak overall results, with a 25% decrease in revenues and a $1 billion adjusted operating loss. Its gross margin slipped badly due to product markdowns and the costs of introducing a number of new clothing lines. The company has attempted to broaden its brand appeal by partnering with leading designers, such as Michael Graves and Jonathan Adler, but the expected rise in customer traffic hasn’t materialized. In addition, J.C. Penney has heavy legacy pension liabilities that continue to siphon off important cash flow.

Looking ahead, J.C. Penney has bet heavily on the in-store boutique experience and Martha Stewart plays a key role in the store transformation process. With almost $3 billion in funded debt, though, the company has a limited timeframe in which to regain profitability and a solid financial footing. One major institutional investor, Vornado, is already getting worried about J.C. Penney’s prospects, as it sold 10 million of its 23 million share position earlier in March. The clock is indeed ticking.

Martha Stewart Living

Martha Stewart founded her empire with the publication of a single book, “Entertaining,” in 1982. Her partnership with Time, Inc., the publisher of the book, later included a popular live television show and a monthly magazine with roughly 2 million subscribers. Despite Martha Stewart’s sustained popularity, though, Martha Stewart Living hasn’t been able to turn a consistent profit over the past five years.

In FY2012, Martha Stewart Living produced mixed results, with a 10.8% decline in revenues, but a 101.7% increase in adjusted operating income. The company’s revenues were negatively affected by the cancellation of a live television show, as well as the decision to end publication of some of the company’s niche magazines. However, Martha Stewart Living benefited from increased sales of licensed products through its diverse merchandising partners, including Macy’s, Home Depot, Michael’s, and Staples.

Looking forward, the company is adapting to the digital age by increasing its online distribution of content, as it recently forged deals with AOL’s On Network and Hulu. Martha Stewart Living has also moved into the radio segment with a new daily radio show, Martha Live, on Sirius XM Radio. The publishing and broadcasting segments remain a sideshow to the company’s licensed merchandising arm, though, which are its only profit center and the source of future growth. Ultimately, Martha Stewart Living needs to find a way to turn its content into gold.

Macy’s

The iconic sponsor of New York’s Thanksgiving Day Parade is winning an increasing number of customers these days, with the right mix of branded products at both its Macy’s and upscale Bloomingdale’s stores. The company’s MyMacy store program allows local management teams to fine tune their inventory selection, leading to lower markdowns and improved inventory turnover. In addition, the company is finding ways to incorporate technology into its business, including Beauty Spot kiosks that allow customers to search and select products based on their profile.

In FY2012, Macy’s produced another year of solid growth, with increases in revenues and operating income of 4.9% and 10.4%, respectively versus the prior year. The company achieved an increase in operating margin due to a strong 41% increase in its online sales, as well as its pruning of selected underperforming stores. More importantly, Macy’s strong cash flow generation, with $2.3 billion in 2012, allows it to continue reinvesting funds in productivity-enhancing store programs, while returning excess funds to shareholders through buybacks.

The bottom line

J.C. Penney’s attempt to upgrade its stores and merchandise selections put it into direct conflict with Macy’s, its larger and more successful competitor. While J.C .Penney has valuable assets, its pension liabilities and lower gross margin place it at a definite disadvantage. Until J.C. Penney and Martha Stewart Living find a way to earn a return, investors need to skip past them and stick with Macy’s.

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