By and  on November 16, 2007

Macroeconomic forces are taking a big toll on consumers, with J.C. Penney and Kohl's being the latest victims of a weaker spending environment.

Hampered by softer sales and gross margin rates, J.C. Penney Co. Inc. posted a 9.1 percent decline in third-quarter earnings on softer sales, while Kohl's Corp. delivered third-quarter profits that fell 13.6 percent, but on higher sales.

Due to the lackluster sales trends, J.C. Penney lowered its fourth-quarter earnings outlook and Kohl's dropped its full-year earnings per share estimate. This followed prior warnings from Macy's Inc., Polo Ralph Lauren Corp., Coach Inc. and Talbots Inc. of the negative impact of a consumer pullback and a more promotional holiday selling season. The consumer spending woes chilled Wall Street Thursday, with the Dow Jones Industrial Average declining 0.9 percent to 13,110.05 and the S&P Retail Index falling 1.1 percent to 420.21.

On Thursday, citing current sales trends, Fitch Ratings issued a report forecasting softer retail sales in 2008 compared with this year. The ratings firm also sees trouble at the high end, with that segment's aspirational buyer pulling back next year. Regarding the current holiday season, Fitch sees a heavy promotional environment aimed at clearing inventories. Most analysts are expecting shoppers to shop later in the season and to hunt for bargains, which will be plenty if current promotional activity is any clue. J.C. Penney, Kohl's, Macy's and a host of specialty stores are in the midst of planned promotions with markdowns of 30 to 50 percent off.

Still, one analyst, Craig Johnson, president of Customer Growth Partners, expects holiday sales to show a gain of at least 5 percent over last year. His analysis, released Thursday, is based on shopping patterns over the past decade. Shoppers are resilient, and they will spend, he said.

That's good news for J.C. Penney's Myron E. "Mike" Ullman 3rd, chairman and chief executive officer, who vowed Thursday to have trend-right merchandise this holiday season to draw in consumers.

For the quarter ended Nov. 3, J.C. Penney said net income dropped to $261 million, or $1.17 a diluted share, from $287 million, or $1.26, in the prior year on sales that slipped 1.1 percent to $4.73 billion from $4.78 billion. Operating income fell 18.5 percent to $411 million. "After the completion of a strong back-to-school season and a favorable response to our early fall merchandise, we were disappointed to see sales weaken dramatically in September and October," Ullman said in a statement.On a conference call with analysts, Ullman said, "For the first time, we really saw a change in consumer sentiment reflecting the soft housing market, the subprime market and the psychological effect of fuel prices. Knowing that we took significant steps to best position ourselves, including laser focus on ensuring our operating expenses are in line with sales levels as well as managing our inventory through targeted promotions, [we will] consistently clear merchandise at appropriate prices within the selling climate."

Ullman said the aim is to have "an ongoing flow of fresh, compelling merchandise going forward. This is particularly important, as we believe the consumers are 'appointment shopping' for the holiday. We believe we are giving them great reasons with our gift assortments to shop at J.C. Penney."

Ullman said, however, that the company is being "realistic about our expectations for the balance of the year to reflect the realties [of the consumer environment]." To that end, the company lowered its fourth-quarter EPS estimate to a range of $1.65 to $1.80 a share, which is down from prior guidance of $2.41. Full-year EPS estimates were lowered to a range of $4.63 to $4.78, which is down from a prior estimate of $5.50 a share.

On the conference call, Robert B. Cavanaugh, executive vice president and chief financial officer of J.C. Penney, said, "Sales trends indicate that consumers are cutting back on some spending, as particularly evident in sales of fall outerwear and home furnishings." The cfo said the successful back-to-school period bodes well for the retailer's position this holiday season.

In regard to the Sephora store-within-a-store, Cavanaugh said: "There are now 47 Sephoras inside J.C. Penney locations and this business is exceeding plan. As we head into the fourth quarter — notwithstanding the overall factors impacting the consumer — we see some encouraging signs. A return to more seasonal temperatures has led to increased traffic and some pickup in the sales of seasonal merchandise. Early response to our holiday assortments has been good as we set stores several days earlier."

During the question-and-answer session on the call, Deborah Weinswig, Citigroup analyst, asked Ullman why women's wear continues to perform well at J.C. Penney. "First of all, I think we are very trend-right, which we learned during July and August," Ullman explained. "We had very, very good selling in juniors, jewelry and casual missy, as well as dresses in our special size business. So I really feel that the combination of our merchandised action teams working together with the trend consultants and product development [offers] what the customer is looking for. Our issue is frankly that we need customers' sentiment to be favorable and we need traffic, particularly in the malls."After the stock market closed Thursday, Kohl's Corp. said its third-quarter earnings dropped 13.6 percent to $194 million, or 61 cents a diluted share, from $224.5 million, or 68 cents a diluted share, in the prior year on sales that increased 4.8 percent to $3.8 billion from $3.7 billion.

"Our sales results reflected a difficult overall environment. We continued to operate our business in a conservative manner, managing inventory investment as we continued our improvement in gross margin while reducing expenses where possible without hurting the customer's in-store experience," said Larry Montgomery, chairman and ceo of Kohl's.

The results prompted the company to lower full-year earnings estimates. Kohl's predicts earnings of $3.52 to $3.58 a share, down from previous estimates of $3.77 to $3.87 a share.

Customer Growth Partner's Johnson said he expects holiday sales to be "in line with average growth rates of the past decade. As we said after 2005's Hurricane Katrina, when gasoline prices rose well above $3 per gallon, Americans are far more resilient than the experts expect. And just as sales rose 7 percent at holiday 2005 despite Wall Street expectations of a low-growth Christmas, 2007 will see over 5 percent holiday sales growth, held down only by a stubborn housing slump."

Johnson said he expects that this year's "It" items "are not handbags, but iPhones and Wii's. Nobody stands in line to buy a handbag or a sweater. But they do stand in line at 5 a.m. at every Wal-Mart and Best Buy in the country on mornings Wii shipments are arriving."

Fitch Ratings said in its report Thursday that "promotional activity is earlier and broader than last year as retailers seek to drive store traffic and clear excess apparel inventory. While recent headlines about toy recalls could divert demand to U.S.- and European-made products, overall toy demand should remain strong. In addition, sales in some categories, such as consumer electronics, should fare better than others, given the price accessibility and continued demand for popular products."

The Fitch report said next year's expected high energy costs; weak housing and credit markets, and increased unemployment rates "will weigh on consumer confidence and spending. While these factors will impact lower-income consumers more significantly than those at higher income levels, consumers at all but the highest income levels are expected to moderate discretionary spending with fewer aspirational purchases and more trading down among retail channels."

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