1 Reason This Retailer Looks Overpriced

Before you go, we thought you'd like these...
Before you go close icon

Mother Nature gave retailers a much-needed break this winter. The mild weather across the nation coaxed shoppers out of their homes, boosting chains such as Target (NYS: TGT) , Macy's, and Gap, which all beat February estimates. One department store lagged behind the competition, however. J.C. Penney (NYS: JCP) reported lower sales last month despite a 50% rise in share price over the past six months.

The stock jumped in January, when CEO Ron Johnson, who joined the department-store chain last November, announced a striking plan to revamp stores. Johnson formerly led Apple's (NAS: AAPL) retail strategy and looks to be taking a similarly bold initiative with his new company. The transformative plan will feature:

  • A three-tiered pricing structure known as "Fair and Square Pricing," with lowest prices offered on the first and third Fridays of each month to clear out inventory.
  • Store redesigns, featuring "brand shops" that include 30 new or transformed brands and a "Town Square" in the center offering various services.
  • Rebranding that includes a newlogo, new signage and presentation, and a monthly 96-point book sent to customers with current promotion. This move also brought in Ellen DeGeneres as a spokesperson.

So where's the Genius Bar?
Johnson, who was a Target executive before going to Apple, certainly deserves some of the credit for driving the iPhone maker's stores to No. 1 in sales per square foot, but J.C. Penney is a different animal. As much as Apple's stores have become part of its brand image, the products it makes -- rather than the in-store experience -- are the principal drivers of the company's success. Furthermore, there's an inherent coolness behind the technology and sleek design in gadgets such as the iPod and iPhone that make an innovative and stylish retail approach a logical end. Divining the same mesmerizing effects out of, say, cable-knit sweaters will prove more challenging.

And finally, even in its darkest days Apple still had loyal devotees who argued that Macs were better and easier to use than Microsoft products. Even the "Think Different" campaign dates back to 1997, after all. J.C. Penney's brand, on the other hand, feels like a relic of past generations. As All-Star Motley Fool CAPS commenter kristm put it:

This isn't your grandma's underwear store. Oh wait, it is. JCPenney is associated with granny panties, 1980's sailor suits, brown living room curtains ordered from a catalog, and tight shoes. For people under 40, there's not a lot to love here.

With a brand perception like that, Johnson clearly has his work cut out for him.

The industry problem
Even with a successful rebranding, J.C. Penney could never hope to achieve the brand power and fat margins that Johnson's former employer had. Unlike the tech industry, department-store retail doesn't benefit from a constant flow of new products rewriting the rules of the industry, and the rise of online shopping presents a further challenge, especially when coupled with creeping gas prices.

Comparing J.C. Penney with other big-box chains shows that even the most successful operators survive on paper-thin margins and that some of its competitors' stocks are priced more affordably.

Company

Profit Margin (Trailing 12 Months)

Price/Sales Ratio

CAPS Score (out of 5)

J.C. Penney(0.88%)0.48*
Wal-Mart (NYS: WMT) 3.51%0.46****
Target4.19%0.55***
Macy's4.76%0.62**
Costco (NAS: COST) 1.62%0.41*****

Source: Yahoo! Finance.

Despite being the only company on the list to lose money last year, J.C. Penney has a P/S ratio that still falls right in the middle of the range.

J.C. Penney would've made $299 million last year without restructuring charges, for a profit margin of 1.73%, which would put it in league with Costco. But the membership-driven, price-club champion is a different model with a strong brand, loyal customers, and dedicated employees. What's more, investors pay a premium for its shares, as its five-star CAPS rating and a P/E near 26 indicate. A more reasonable profitability standard would be north of 4%, closer to Macy's and Target. But considering J.C. Penney's P/S ratio is on par with its peers, expectations that it will reach that level appear to be baked into the share price. Excluding the restructuring charges, J.C. Penney's P/E ratio would be a lofty 27 for the past 12 months.

Foolish takeaway
Investors appear to be assuming the best for J.C. Penney, but the rebranding is off to an inauspicious start. The company launched its transformation on Feb. 1 with the new logo and pricing strategy and the monthly promotional cycle, but consumer response was underwhelming. At the 18 retailers that reported February sales, comps rose by a solid average of 6.4%, compared with 4.7% a year ago. J.C. Penney, however, continued its slide from the fourth quarter, when same-store sales declined 1.8%.

The stores' transformation won't be completed until 2015, and it will be exciting to see whether Johnson can bring some of that Apple magic to the fading retailer. Considering the company's lofty share price, however, investors seem to think they can still have the cake they just ate.

While J.C. Penney may not have the upside potential investors are looking for, there's another retailer that our chief investment officer named as his "Top Stock for 2012." It has a foothold in emerging markets, the share price has nearly doubled in the past year, and there's plenty more room for growth. You can get our special free report all about this hot stock that's still flying under Wall Street's radar.

At the time this article was published Fool contributorJeremy Bowmanholds no positions in the companies above, though he's still holding on dearly to a closet full of 1980s sailor suits. The Motley Fool owns shares of Wal-Mart Stores, Apple, Microsoft, and Costco Wholesale. Motley Fool newsletter services have recommended buying shares of Costco Wholesale, Apple, Microsoft, and Wal-Mart Stores, creating a diagonal call position in Wal-Mart Stores, and creating bull call spread positions in Apple and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insightsmakes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.

From Our Partners