J.C. Penney's move into appliances will hurt Best Buy and Sears

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Earlier this year, J.C. Penney (NYSE: JCP) said that it would test selling appliances in three markets beginning in February. The test was extremely successful, adding several percentage points to J.C. Penney's comp sales growth in those stores, bringing in new customers, and spurring lots of credit card sign-ups.

As a result, J.C. Penney recently announced that it will roll out appliance sales more broadly. The company has already started to sell appliances online and will add appliance showrooms to nearly 500 stores -- about half of its total store count -- by the fall.

This push into the appliance market could take a toll on two of the biggest appliance sellers in the U.S.: Sears Holdings (NASDAQ: SHLD) and Best Buy (NYSE: BBY).

Breaking into the concentrated appliance market

The U.S. appliance market is dominated by a small number of retailers today. Five retailers -- Sears, Lowe's, Home Depot, Best Buy, and Sears spinoff Sears Hometown & Outlet Stores -- account for about $20 billion in annual appliance sales: roughly two-thirds of the market.

Among that set of retailers, the home improvement retailers probably have less to lose from J.C. Penney's entry into the appliance market. First, they aren't facing the same kind of secular sales pressure as Sears and Best Buy. Second, J.C. Penney's focus on selling appliances to women likely gives it more target demographic overlap with Sears and (to a lesser extent) Best Buy.

Extrapolating out from the early sales in its three test markets, J.C. Penney could quickly reach $400 million in annual appliance sales. As consumer awareness increases, appliances could easily become a billion-dollar business for J.C. Penney in the next few years.

That would still make it a much smaller player in the market than Sears or Best Buy. But Sears and Best Buy can ill afford any increase in competition for appliance sales.

Sears needs appliances to stay relevant

Appliance sales have risen significantly in the last few years as the improving economy has driven an increase in homebuilding and home renovations. While Sears has lost its dominant position in the U.S. appliance industry over the past decade, appliances have remained one of its stronger business lines.

By contrast, the bulk of Sears' business has become increasingly irrelevant. Revenue has been eroding steadily for many years now and the company is consistently unprofitable. To make matters worse, Sears' comparable store sales declines have accelerated recently.

Sears and J.C. Penney are the two biggest mall-based, mid-market department stores. Thus, it stands to reason that J.C. Penney could steal a lot of customers from Sears as it ramps up appliance sales. That would put yet another nail in Sears' coffin.

Appliances have been a bright spot for Best Buy

While Sears was the traditional appliance market powerhouse, Best Buy is an up-and-coming challenger. In recent years, it has profited from a combination of strong underlying growth in appliance demand and market share gains.

Appliances are still a relatively small part of Best Buy's business, representing 9% of its domestic sales last quarter. However, that's up from just 5% of the domestic sales mix five years ago. This growth in appliance sales has helped Best Buy offset weaker sales trends in other categories.

Best Buy is likely to continue facing stiff headwinds in its core markets in the coming years. The mobile market has become saturated, PC and printer sales are steadily declining, and TV prices are falling rapidly. It's not clear that consumer electronics growth categories will be able to offset these declines any time soon.

Strong appliance sales growth has thus been a key lever supporting Best Buy's sales and earnings lately. Competition from J.C. Penney could reverse some of those gains -- while J.C. Penney's promotional strategy could also threaten Best Buy's profit margin.

J.C. Penney may never become one of the top five appliance retailers in the U.S. But even with a smaller share of the market, it could do a lot of damage to both Sears Holdings and Best Buy.

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