Bad News for Sears Is Good News for J.C. Penney

Last week, Sears Holdings (NASDAQ: SHLD) released another dreadful quarterly earnings report. Comp sales declined 11.9%, and total sales plunged more than 30% year over year. A combination of weak gross margin and the sharp comp sales drop more than offset savings from Sears Holdings’ aggressive cost cuts, causing profitability to deteriorate further.

Sears Holdings has responded by announcing another round of store closures. Including some other store closure decisions that have trickled out over the past month or two, the company is now set to shutter more than 15% of its remaining Sears full-line stores in the next few months. This could provide a big lift to J.C. Penney (NYSE: JCP): Sears’ closest competitor.

Sears store closures accelerate

Sears Holdings has been shrinking for years. However, management made a conscious decision about two years ago that the company couldn’t afford to keep money-losing stores open just to maintain scale or in the hope of an eventual recovery. Since then, the pace of store closures has accelerated dramatically.

Sears has finally decided to throw in the towel on stores that are losing money. Image source: Sears Holdings.

Initially, the Kmart chain bore the brunt of the store closures. In January 2016, Sears Holdings operated 941 Kmart stores. As of a month ago, it had just 365 — a decrease of more than 60%.

By contrast, there were 506 full-line Sears stores operating in early May, down from 705 in January 2016. This 28% reduction was certainly substantial, but not on the same scale as the Kmart downsizing.

Recently, the Sears chain has been suffering even greater comp sales declines than Kmart. It’s no surprise that this is turning previously profitable stores into money-losers. As a result, on Thursday, Sears Holdings released a list of 63 stores — made up of 15 Kmarts and 48 full-line Sears stores — that it will close in early September. This comes on top of 42 other store closing decisions (including 33 full-line Sears stores) identified by Business Insider since mid-April. Most of those locations will close in July or August.

J.C. Penney is ready to pounce

As Sears has shrunk over the past two years, J.C. Penney executives have openly stated that they aim to capture as much of the business that Sears is giving up as possible. To do this, J.C. Penney has installed appliance showrooms in about 600 stores and gradually expanded the range of brands it carries. (For example, it added Frigidaire to its roster last fall.) J.C. Penney has also increased the furniture assortment it sells online and devoted more floor space to mattresses.

J.C. Penney has added appliance sections to nearly 600 stores since early 2016. Image source: J.C. Penney.

Skeptics doubt that these initiatives can move the needle for J.C. Penney. After all, the company fell well short of its earnings guidance last year, due in part to the lower gross margin structure of the appliance category relative to J.C. Penney’s traditional apparel business. Its guidance for 2018 wasn’t very encouraging, either. Lastly, sales came in below expectations last quarter.

However, J.C. Penney had to deal with very unfavorable weather trends last quarter. Meanwhile, many of its less weather-sensitive categories — including appliances, furniture, and mattresses, as well as toys — are seasonally weak during the first quarter. Thus, the benefit from market share gains in these categories is likely to be much larger during the remainder of the year.

The Sears store closures that will go into effect between now and early September represent a significant opportunity for J.C. Penney. Two-thirds of the 81 Sears stores slated to close have a J.C. Penney in the same mall (or in one case, right across the street). All but seven of those J.C. Penney stores have appliance departments. Several of the remaining 27 Sears stores that are closing have a J.C. Penney location within a few miles.

By mid-September, more than 10% of J.C. Penney stores will be benefiting from the recent closing of a nearby Sears. The 2016 and 2017 Sears store closures didn’t have nearly as much overlap with the J.C. Penney store base.

This could be a much-needed shot in the arm

Sears’ revenue has eroded rapidly in recent years, but its full-line stores still generated $1.4 billion of merchandise sales last quarter. For comparison, merchandise sales slipped to $2.6 billion at J.C. Penney. Sears wasn’t that far behind J.C. Penney. (That said, the average Sears full-line location is larger than a typical J.C. Penney store.)

Thus, the impending closure of more than 15% of Sears’ full-line stores — along with the closure of another 10% of the Sears store base that has occurred since January — will create a meaningful revenue growth opportunity for J.C. Penney.

Up until now, while J.C. Penney has made sales gains at Sears’ expense, it hasn’t been enough to offset missteps in its apparel business and other sources of earnings pressure. That could be about to change. With appliance departments and expanded mattress sections already rolled out to most of its stores — and a larger selection of furniture online — J.C. Penney can ramp up sales in those categories without significantly increasing inventory or cannibalizing other departments.

On the other hand, if J.C. Penney fails to seize this opportunity over the next year or so, it would serve as a strong indication that the company’s turnaround strategy is fatally flawed.

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Adam Levine-Weinberg owns shares of J.C. Penney. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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