Why Macy's, Kohl's, and J.C. Penney Had a Rough January

By Timothy Green Markets Fool.com

What happened

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Shares of department store chains Macy's (NYSE: M), Kohl's (NYSE: KSS), and J.C. Penney (NYSE: JCP) tumbled in January, according to data provided byS&P Global Market Intelligence, dropping 16.2%, 20%, and 20.2%, respectively. All three companies reported lackluster holiday sales results, featuring comparable-sales declines across the board and slashed profit guidance at Macy's and Kohl's.

So what

The department store industry has been in a funk for years, with total revenue slumping considerably over the past decade. Discounters like Wal-Mart, wholesale clubs like Costco, and online retailers like Amazon.com have all been taking their toll. The department store model of generating gross margin in the mid-30s and advertising heavily to drive store traffic is in genuine peril.

Image source: Macy's.

The holiday season has become an all-out promotional slugfest to attract foot traffic, and the department stores are losing the battle. Macy's reported a 2.1% decline in comparable sales during November and December, with weakness in handbags and watches hurting its results. The company pointed to changing consumer behavior as having a major impact on sales, and while its e-commerce business grew at a double-digit rate, it's not yet big enough to offset the poor performance of its stores.

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Macy's slashed its guidance for 2016 due to its poor performance during the holidays. The company now expects comparable sales to slump by around 3%, the low end of its previous guidance range. Adjusted EPS, previously expected between $3.15 and $3.40, is now expected to come in between $2.95 and $3.10.

The same story played out at Kohl's. Despite efforts to manage inventory and avoid profit-killing markdowns, Kohl's holiday season was its worst in years. Comparable sales in November and December slumped 2.1%, down from a 0.4% increase during the same period in 2015. The company saw volatile sales throughout the holiday season, with weakness sandwiched between a strong Black Friday and week before Christmas.

Kohl's also slashed its full-year guidance in response to its disappointing performance. Adjusted EPS is now expected to come in between $3.60 and $3.65, down from a previous guidance range of $3.80 to $4.00. Gross margin will be lower than anticipated due to the mix and timing of sales and a competitive promotional environment.

J.C. Penney's results look best on the surface, but the company's sales are still so depressed that anything short of growth is a disaster. Comparable sales fell 0.8% during November and December for J.C. Penney, a number that would have been viewed as borderline-positive for either Macy's or Kohl's. But J.C. Penney is still unprofitable as is works to slowly recover from the steep sales decline it suffered in 2012, so declining holiday sales are a major problem.

J.C. Penney still expects to produce EBITDA of around $1 billion during 2016, and it predicts to continue its recent streak of producing positive operating profit. But interest on its excessive debt load will erase that profit and then some.

Now what

Action is already being taken in response to the weak holiday results. Macy's announced on Jan. 4 that it plans to close 68 stores by mid-2017, with another 30 expected to be closed over the next few years. The company is also restructuring its operations, with plans to eliminate layers of management, cut non-payroll costs, and reduce its field infrastructure. As part of this effort, 6,200 jobs are expected to be eliminated.

Macy's has also been selling some of its real estate, and that effort could intensify going forward as the company looks to unlock value. Rumors of a potential takeover bid from Hudson Bay, the owner of Saks Fifth Avenue, surfaced in February, pushing up the stock as a result. This erased a portion of January's drop, but the stock remains down considerably.

J.C. Penney also plans to close some stores, although a concrete strategy hasn't been announced. While most J.C. Penney locations are now profitable, according to CEO Marvin Ellison, sales remain stubbornly low. Kohl's hasn't announced much of anything as a response to its poor holiday season, but store closings in 2017 wouldn't be a surprise.

The number of department store locations is set to decline going forward as the industry struggles to compete. Macy's and Kohl's are both possible buyout candidates, with plenty of cash flow generation despite sluggish sales. J.C. Penney has a tougher challenge ahead, with the company still losing money and unable to keep its previous streak of sales growth alive. With the department store industry in turmoil, January's slump in the stock prices of these three companies may be just the beginning.

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Timothy Green has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon and Costco Wholesale. The Motley Fool has a disclosure policy.