Ok.. this is the latest J.C. Penney Company, Inc. (NYSE:JCP) report to have a strange title, but the content is good. Earlier, this week we brought you via Citigroup this one-Many ‘male Fashionistas Shopping the Assortment with Overflowing shopping Carts’ at J.C. Penney: Citi (which is very hard to match). The latest from Ike Boruchow of Sterne Agee focuses not only on Penny business model but also on the competitors (something which seems to be lacking in many recent reports). Even though this is ‘officially’ a retail report the focus really is mostly on J.C. Penney Company, Inc. (NYSE:JCP) specifically. Below is the full summary, some nice data for bears, bulls and everyone in between to dissect.
Via Ike Boruchow and Tom Nikic, CFA of Sterne Agee: Everything You Wanted to Know About J.C. Penney Off-Price Impact… But Were Afraid to Ask
On the heels of our recent Ross Stores, Inc. (NASDAQ:ROST) upgrade to Buy, we are addressing the key investor pushback on the off-pricers today: what if JCP gets better? Our view is that the off-pricers (both ROST and TJX) did not materially benefit from JCP’s 2012 struggles. Backing our view: 1) comp trends actually weakened throughout 2012 (as JCP’s trends materially decelerated), 2) annual comp growth was not dissimilar to prior years and 3) neither off-pricer experienced a larger-than-normal increase in its vendor base. As a result, we remain buyers of both ROST and TJX and feel that the pushback is unjustified.
Primary Investor Concern = JCP Improvement. Since our June 13 upgrade of Ross Stores, Inc. (NASDAQ:ROST) to Buy (TJX already a Buy), we’ve received some investor pushback on the basis that the off-pricers got a meaningful benefit from JCP struggles in 2012, and if a return to form occurs at JCP in 2013, these will be the most negatively impacted concepts. Further, recent survey work conducted by Sterne Agee Broadlines analyst Chuck Grom illustrated that investors believe the #1 beneficiary of last year’s struggles at J.C. Penney was the off-price channel (29% of respondents). We feel these concerns are overblown for several reasons.
Reason #1: Off-Pricers Slowed as J.C. Penney Worsened. Both ROST and The TJX Companies, Inc. (NYSE:TJX)’s Marmaxx segment experienced sequential deceleration of comp trends as 2012 progressed, as JCP’s comps deteriorated. Further, the two-year stacks for both companies were virtually unchanged throughout 2012. Also, both companies have conducted analyses on stores within varying distances of JCP locations and the results did not suggest any increased share gains for stores closer to a JCP.
Reason #2: 2012 Comps Were Par for the Course. During 2009-2011, ROST and Marmaxx averaged 5-6% comps, fairly in line with 2012’s +6% comp posted by both concepts. The exact three-year comp average for both off-pricers is 5.3% – just 70bps below 2012’s comp. Net/net, we don’t view this as an abnormal annual performance.
Reason #3: Consistent Vendor Increases. On top of comp benefits, some investors are concerned that last year the off-price channel gained new suppliers, and these vendors could leave the channel if JCP’s performance improves. We’d note that in 2012 TJX added the same number of vendors (1,000) as it did it 2011, while ROST only added 100 vendors, the same as in 2010 (2011 was flat). Even if some of these new relationships were forged due to JCP’s struggles, this is a benefit that is not likely to reverse. Vendors find working with off-pricers favorable, as they have wide distribution, will accept less-than-full assortments, do not ask for markdown/return allowances and pay their bills on time.
? Risk to Old Navy Underappreciated. Looking back at the investor survey, Old Navy/Gap was the least frequent choice when investors were asked who benefited most from J.C. Penney’s 2012 struggles (just 11% of respondents). However, we note that Old Navy’s comps actually accelerated as J.C. Penney worsened in 2012, and since 2011 the correlation between comps at Old Navy and JCP is -0.90, a far stronger inverse correlation than either ROST or TJX (-0.40 each). Old Navy and JCP are both value-priced, mall-based retailers, which makes customer migration between the two stores more likely than the off-mall off-pricers.
Investor Pushback to Off-Pricers: JC Penney Improvement
In a survey recently conducted by Sterne Agee Broadlines analyst Chuck Grom, investors were asked who they believe was the largest beneficiary of JCP’s $4.3 billion sales decline in 2012. The #1 response (29%) was the off-price channel. This coincides with our recent discussions with the investment community, as sentiment has begun to turn incrementally negative on both TJX and ROST (both Buy rated) given recent speculation that JCP may begin to improve as it moves back to couponing and discounts.
We believe that investors view share gains from JCP as a material driver of the solid comps achieved by Marmaxx and ROST last year (both posted 6% comp increases in 2012). After the off-pricers, the #2 response from investors (27%) was the regional department stores (such as Stage Stores and Dillards), then there was a fairly large drop-off to the #3 response (WMT and TGT) at just 18%. Interestingly, the only specialty player on the list was The Gap Inc. (NYSE:GPS) (Old Navy and Gap), which finished last at only 11% of responses.
JC Penney as a Risk to Off-Price Not Supported by Numbers
If share gains from J.C. Penney were in fact a material driver of comps for off-price in 2012, this would implicitly suggest a risk to 2013 performance if J.C. Penney sales trends improve and customers leave the off-price channel to return to J.C. Penney. While this may seem logical (both JCP and the off-price retailers are big-box destinations that offer value-priced apparel and home furnishings), this thesis is not supported by examination of the numbers. On the other hand, we believe that the numbers do show that Old Navy (40% of GPS revenue) was a material beneficiary of J.C. Penney’s struggles, and we see more risk there. (We currently rate GPS Underperform.)
Off-Pricers Slowed as J.C. Penney Company, Inc. (NYSE:JCP) Worsened
First, when we look at comp trends within 2012, we see little evidence that the off-price channel benefited from JCP’s woes. JCP’s comps got worse as the year progressed, starting from -18.9% in Q1 and ending at -31.7% in Q4. However; both ROST and Marmaxx also experienced sequential comp decelerations throughout the year. (ROST began the year at +9% in Q1 and ended at +5% in Q4, Marmaxx comps were +8% in Q1 and slowed to +4% in Q4.) If the off-price channel had experienced a significant influx of displaced JCP customers, we believe comps would have accelerated as the year progressed. Further, the two-year stack at ROST was basically flat at 12% throughout the year, while TJX decelerated slightly to 10% in Q4 from 12% in Q1. Thus, we see little evidence that the strong performance of off-price last year was driven by an exodus from JCP.
On the other hand, Old Navy showed improvement throughout 2012, beginning in Q1 when comps improved materially (to +3% from -6% in 4Q11) amid a sharp deceleration at J.C. Penney (to -18.9% from -1.8%). In the back half of the year, Old Navy comps improved to 8-9% as J.C. Penney Company, Inc. (NYSE:JCP) posted declines of -26.1% and -31.7%. Thus, we see more evidence that Old Navy benefited from JCP share loss than the off-price channel did. Last, we’d note that over the last two years, there is a much stronger inverse correlation with J.C. Penney Company, Inc. (NYSE:JCP) comps at Old Navy (-0.89) than at ROST or TJX (-0.41).
J.C. Penney Company, Inc. (NYSE:JCP) 2012 Results Were Essentially in Line with 3-Year Average
Second, we’d note that neither Ross Stores, Inc. (NASDAQ:ROST) nor TJX’s Marmaxx segment posted comps significantly outside recent trends. For example, from 2009 to 2011 ROST’s quarterly comps ranged from 3% to 10%, encapsulating the 2012 range of 3% to 9%. Annual comps ranged from 5% to 6%, with 2012 within the range at +6%. At Marmaxx, meanwhile, 2009-2011 quarterly comps ranged from 1% to 13%, encapsulating the 2012 range of 4% to 8%. Annual comps ranged from 4% to 7%, with 2012’s within the range at 6%.
We’d also point out that unlike the off-pricers, GPS’s Old Navy brand experienced a significant improvement in 2012. Last year Old Navy posted comps of 3% or better every quarter, whereas comps were 2% or worse in 9 of 12 quarters from 2009 to 2011 (including 5 negative quarters). Also, Old Navy achieved strong comp growth of 9% and 8% in 3Q12 and 4Q12, respectively, but from 2009 to 2011 it achieved only one quarter of growth above 7% (a 10% gain in 3Q09 against a very easy -19% compare). On an annual basis, Old Navy averaged 1% growth from 2009 to 2011 (+/-3%), but comps accelerated significantly to 6% in 2012. Given that Old Navy, like J.C. Penney Company, Inc. (NYSE:JCP), is a promotional, mall-based, value-priced retailer, we believe customer migration between J.C. Penney Company, Inc. (NYSE:JCP) and Old Navy is more likely than migration between JCP and the off-pricers.
J.C. Penney Company, Inc. (NYSE:JCP): Vendor Migration Not a Material Concern
We believe there is concern that J.C. Penney Company, Inc. (NYSE:JCP)’s struggles last year allowed ROST and TJX to develop new relationships with vendors who will then abandon the off-price channel in favor of a reinvigorated JCP, reducing the quality and breadth of the off-price assortment. However, we’d note that neither off-price retailer experienced unusual growth in the supplier base in 2012, as TJX added the same number of vendors (1,000) as it did in 2011 (note that expansion may have come from the growing international business or the Sierra Trading Post acquisition), while ROST only added ~100 vendors, or a 1% increase in the supplier base. Further, if these companies did establish new vendor relationships, we do not expect these suppliers to stop working with the off-pricers even if J.C. Penney Company, Inc. (NYSE:JCP) sales trends improve. We believe that suppliers greatly enjoy working with ROST and TJX for the following reasons:
1. They are willing to purchase less-than-full assortments.
2. They can distribute product to over 4,000 stores combined, in a wide array of geographies.
3. Unlike department stores, they do not require allowances for returns, markdowns, or advertising and typically pay cash.
4. They are not constrained by category limits, as their “no walls” store model allows floor space to be rearranged extremely easily to adjust for changes in availability by category.
J.C. Penney Company, Inc. (NYSE:JCP): A Strong Business Model For All Competitive Environments
We believe that customer loss to J.C. Penney Company, Inc. (NYSE:JCP) is not a significant risk for TJX Companies, Inc. (NYSE:TJX) and ROST because of the attractive shopping experience these stores provide. In our view, customers who do not shop the channel assume that the merchandise is either off-trend or defective, and that firsttime shoppers are pleasantly surprised to discover on-trend fashions at extremely affordable prices. We believe customers also enjoy the “treasure hunt” aspect of shopping at off-price stores. Thus, we believe that customer loyalty is extremely high, and trade-up is not a significant risk.
The historical performance of both Ross Stores, Inc. (NASDAQ:ROST) and TJX Companies, Inc. (NYSE:TJX) demonstrates a business model that performs well in virtually all competitive and economic environments. In its 35 years of existence, TJX has only once posted negative same-store sales, a 2% decline in 1995. ROST, meanwhile, has posted positive comps every year except 2004, when comps declined 1%
amid severe supply chain disruptions from a technology systems conversion and a roof collapse at a distribution center. Both companies have posted solid comp growth during both favorable and unfavorable economic/competitive environments
We’d also note that given the wildly fluctuating comps at Old Navy (monthly comps ranging from -12% to +13% since the start of 2011), there is much less customer “stickiness” there, relative to the more-stable off-pricers (comps generally +MSD, ranging from flat to +10%).