Moment of Truth: Will JC Penney and Sears Survive?

We have just gone through a very difficult retail season. Christmas sales results have been pretty good for many retailers but there are exceptions including JCPenney, Sears, Target, Kohl’s, and domestic Gap.  Now we wait for earnings to be tabulated.

In mid-February the major retailers will begin publishing their 4Q12 earnings; some will be very disappointing. Companies like Kohl’s have already lowered investor’s expectations by reducing their guidance for fiscal 2012 as well as 2013. Similarly Sears Holding has indicated that the fourth quarter sales were disappointing with sales dropping —- and earnings are also likely to be below last year. This happened despite the fact that Sears stores are picking up some apparel sales from J.C.Penney stores

Let’s face it, retailers started to take markdowns as early as December 10, when JCPenney started slashing prices. This was not planned.  As soon as a retailer starts to take unplanned markdowns it is cutting into gross margins and thus its ultimate earnings potential.  Some merchants will get assistance from their suppliers who help pay for the markdowns. However, for JC Penney I do not believe this was the case where markdowns were clearly taken in haste.

Marked-down merchandise was in the JCP weekly circular at regular prices just one day before the prices were lowered.  This doesn’t allow time to negotiate with vendors for support.  In contrast, Macy’s had a special pre-Christmas sale when all stores were open around the clock to encourage shoppers to shop which was planned in advance and well advertised.  Other stores waited until just before Christmas to reduce some of the slow selling merchandise like sweaters and men’s shirts hoping to move the bulk of goods by capturing the attention of last-minute undecided shoppers, and likely allowing some time to work out support with suppliers.

There was an offset this year to the profit eroding markdowns that once again played a big part in this year’s Holiday story.  For the first time in my memory, some retailers did not add to their selling staff, thus keeping the selling costs in check. Typically retailers have squads of seasonal employees to augment their regular staff. These workers were usually discharged on December 24 leaving regular associates to handle the return of unwanted gifts after the holiday.  The challenge of converting a return into a new sale was always left to regular employees.

According to U.S. Labor Department report apparel and accessories stores cut 18,700 employees after adding 32,000 in November. Department stores trimmed 4,800 jobs in December. General merchandise stores added a meager 300 jobs in that month. This unusual move was probably caused by concern about the “fiscal cliff” that might reduce consumer spending. I suspect that some stores resorted to using overtime for their regular people as a means to have tight controls of the selling budget.

In the report, the Labor Department noted the loss of 350 jobs on average in department stores during the past four months in contrast to specialty stores.  I attribute this in part to JC Penney’s need to cutback of associates given drastically lower sales levels.  In my blog of December 7, 2012 I estimated that JC Penney’s sales in the fourth quarter would be lower by 26 -30%;  I still believe this to be the case.

The fourth quarter is when retailers earn a significant portion of their annual profits.   The amount a retailer earns is a reflection of management’s ability.  Its skill in understanding fashion trends and the right level of mark-up on merchandise, as well as the proper level of inventory, and the intelligent staffing of stores makes the all the difference.  These are the critical management decisions that translate into financial success for the retailer, its suppliers and investors.  I continue to worry that some retailers – like Sears and JC Penney — have not grasped the need for reporting profitable growth in the fourth quarter.  Only through intelligent and innovative management can a store thrive; 4Q earnings will show some retailers are missing the boat.

Forbes.com