Traditional department stores are dying before our eyes. Shares of JC Penney (NYSE: JCP), the quintessential middle-class retailer were trading at $2.44 on 6 July 2018. Meanwhile, shares of the glorified bargain basement operator TJX (NYSE: TJX) were trading at $95.55 on July 6, 2018.
The financial numbers show us why TJX is doing so well and Penney’s dying before our eyes. TJX reported a year-to-year revenue growth rate of 11.62% and revenues of $8.689 billion for the 3rd Quarter of 2018. In contrast, Penney’s reported a revenue growth rate of 1.77% and revenues of $4.031 billion for 2nd Quarter 2018.
More tellingly, Penney’s recorded a net income of just $254 million for 2nd Quarter 2018, while TJX raked in $716.38 million in net income and $716.38 million in operating income.
Disturbingly Penney’s 2nd quarter operating income was $247 million which was lower than its net income. That figure indicates that at least part of Penney’s income is coming from borrowing rather than selling merchandise.
Is JC Penney Making Money?
Such numbers raise the obvious question is JC Penney making money? Judging by net income the answer is yet, but the balance sheet tells a different story.
On February 3, 2018, JC Penney reported $458 million in cash and equivalents and $4.332 billion in total debt. Penney’s reported an operating cash flow of $637 million and a free cash flow of $529 million on February 2, 2018. That indicates Penney’s lacks the funds to pay its debts.
The company either has to borrow or sell assets to raise capital. That explains why Penney’s has been quietly closing stores in some markets.
It also explains why Penney’s CEO Marvin Ellison could not hand in his resignation fast enough when he was offered the top job at Lowe’s (NYSE: LOW). The home-improvement giant reported a free cash flow of $3.210 billion, revenues of $17.360 billion and a gross profit of $6.012 billion for 3rd Quarter 2018.
Lowe’s stock price of $96.14 on 6 July 2018, probably caught Ellison’s eye as well. There is one certainty here, Ellison’s departure leaves Penney’s in a far worse position.
Penney’s is no Longer Competitive
The bottom line is that JC Penney is no longer competitive. It lost the home improvement and appliance business to Lowe’s and Home Depot (NYSE: HD), the clothing wars to Macy’s (NYSE: M), Walmart (NYSE: WMT) and Amazon (NASDAQ: AMZN), and the lower-middle class shopper to TJX.
An obvious trend that Penney’s failed to take advantage of was deep discounting particularly in clothing. A number of retailers including Target (NYSE: TGT), TJX, Costco Wholesale (NASDAQ: COST), Walmart, and Amazon have been able to undercut Penney’s prices for clothing, shoes, and home furnishings – sometimes dramatically.
Discounting is critical because increasingly cash-strapped working and middle-class households need to save every penny they can. TJX’s success is partially the result of growing wage stagnation and income inequality in the Midwest and Northeast. It is no coincidence that TJX has enjoyed some of its biggest success in the cities with the biggest income inequality and housing affordability problems like New York.
The TJX business model is selling high-quality clothing; often unsold fashions from other retailers, at the lowest price possible. In recent years, TJX has expanded that business model to home furnishings with a lot of success.
Instead of copying that successful paradigm, Penney’s limped along with its traditional business model of selling middle-priced merchandise to the middle class. When the middle-class did not buy or died off Penney’s suffered.
A final nail in the coffin was Penney’s old-school business model of mall-based anchor stores. The consumers that Penney’s needs most; younger middle and working-class customers are avoiding the mall like the plague.
Can Instacart Save Penney’s or Jump Start TJX?
There is a technology company that might save Penney’s, and make TJX competitive with Amazon. That company is Instacart, which combines an online grocery service with same-day delivery.
Instacart’s business model is pretty simply, it uses professional shoppers to pull orders from existing brick and mortar stores. The same shoppers then deliver the orders to the customer.
The opportunity for Penney’s or TJX here is to become the first department store on Instacart. Have their drivers pull the clothing, household goods and other items customers order through Instacart.
Going on Instacart would put TJX or Penney’s merchandise in front of consumers that do most of their shopping through their phones. It will reach shoppers that never go to brick and mortar stores.
Instacart is where the Millennials and Generation X will shop. It also appeals to the consumers TJX needs most the harried middle and working class soccer moms.
The Instacart Opportunity
Questions remain here including how returns will be done, the roles of robots and self-driving vehicles, and if customers will trust Instacart with clothes. TJX should certainly look into such a service because one of its biggest rivals, Target bought the shopping service Shipt. Walmart is making an even more aggressive push into same-day delivery.
There is an opportunity for value investors here. Retailers like JC Penney and TJX with their established brand names, fleets of stores, buying power, advertising, and staffs are well-positioned to take advantage of the Instacart opportunity.
Value investors need to take a second look at JC Penney and TJX, because they might have some interesting expansion opportunities in the age of Instacart. Brick and mortar stores that Wall Street has written off might be exactly what Instacart needs to expand beyond groceries.