By  on May 28, 2007

FORT WORTH, Texas — J.C. Penney keeps raising the bar.

Over the past seven years the company has transformed itself from an uninspired mall placeholder selling dowdy basics, to the department store of choice for the moderate customer. Its merchandising and marketing efforts have received accolades within the industry, its same-store sales continue to increase and its stock price has risen more than tenfold since 2000

After achieving the goals of a five-year plan within two years, Penney’s unveiled an aggressive new strategy last month that upped the ante.

As chairman and CEO Myron (Mike) Ullman 3rd said in a recent speech: “The reaction of the team was not, ‘Great, let’s take the next three years off.’ Our 2007–2011 plan ... aspires to a different level. The team feels good about stretching themselves.”

And stretch they will: Penney’s has publicly stepped forward with a plan that calls for adding 250 new stores by 2011, mostly off-mall; posting overall sales gains of 9 percent; and comps that will rise in the mid- to low-single digits within that time frame. Other targets include posting operating income of between 12 percent and 12.5 percent of sales—up from 9.7 percent in 2006—and earnings per share of 16 percent on a compounded annual growth rate. Gross margins are expected to reach 40 percent in 2011, while operating expense ratios are seen hitting 28 percent of sales in 2011. In addition to the new units, some 300 stores will also be renovated by 2011—resulting in an 18 percent increase in square footage.

The goal, according to Ullman, is to reach “an industry leadership position by 2011.”

The company is already well on its way. In 2006 the retailer managed to exceed its 2007 sales plan of $19.9 billion with a 6 percent rise in sales. It also exceeded its 2008 income plan by hitting $1.9 billion, and its 2009 profitability target of 9.7 percent.

Ullman categorized 2006 as “a very busy and successful year. J.C. Penney has a major competitive advantage: We have 600 mall stores paired with 400-plus off-the-mall stores—45 percent private label and 55 percent national brands—for a total of 1,000-plus stores working in synergy with our Web site and catalogs.”

Success continued in the first quarter as well. For the period ended May 5, profits jumped 13.3 percent to $238 million, or $1.04 a diluted share, from $210 million, or 89 cents, in the same year-ago quarter. Total sales rose 3.1 percent to $4.4 billion from $4.2 billion. Total department stores gained 4.4 percent, while same-store sales rose 2.2 percent. Internet sales increased 18 percent in the first quarter with good results in apparel categories.

The results beat analysts’ expectations by 1 cent. In addition, the retailer increased earnings guidance for the year, raising estimates to $5.49 a share from $5.44.

Ullman believes Penney’s has been successful for several reasons, not the least of which is the changing department store climate in the U.S. Specifically, Penney’s zeroed in on the moderate-income customer as Federated Department Stores opted to change all the nameplates of its newly acquired May Department Stores units to Macy’s, which generally offers a product with a higher price point. And the combination of Sears and Kmart also opened up a window of opportunity that Penney’s was quick to seize.
Penney’s has successfully created “an emotional connection” with its customers by adding new, exclusive brands such as Concepts by Claiborne and Solitude, while enhancing its eight private-label “power brands”—Ambrielle, a new women’s lingerie label; a.n.a., a women’s sportswear brand; Chris Madden and Cooks for the home; St. John’s Bay and Stafford for the traditional customer; Arizona, for young men’s, juniors’ and children; and Worthington, a women’s career label.

But that’s not all. Penney’s made headlines when it signed on as the first retailer with Polo Ralph Lauren’s newly formed Global Brand Concepts to develop and market a new brand, American Living. When that label debuts next spring, it will be the largest launch in Penney’s history.

In young men’s and juniors’, Penney’s has hooked up with red-hot California twins Chip & Pepper for an exclusive denim and sportswear collection, C7P...A Chip & Pepper Production, slated to hit stores for the back-to-school season. Also creating buzz is Penney’s joint venture with Sephora, the popular beauty brand, to roll out in-store shops, and its plan to open its first Manhattan unit—a stone’s throw from the Macy’s flagship—sometime in late 2008 or 2009.

Other drivers of Penney’s aggressive growth plan include the further development of—currently a $1.3 billion business that is expected to have sales gains in the mid-single digits over the next five years—as well as a new merchandise-flow strategy that is expected to improve sales and gross margins, and lower markdowns. Under this new strategy, the company said, Penney’s has reduced its cycle time to 40 weeks from 50 to 52 weeks. Its goal is to hit 25 weeks.

In February, Penney’s kicked off a new marketing campaign and tagline—Every Day Matters—designed to “build a defensible brand positioning for the company.”

All of these initiatives have made competitors take notice. In his annual chairman’s letter to shareholders, Edward Lampert of Sears Holdings, which operates the Sears and Kmart nameplates, referred several times to Penney’s. “J.C. Penney’s turnaround efforts included a challenge to the company’s merchants to benchmark their results against those of their best-in-class competitors in each category,” he wrote.

“Benchmarking ourselves against the best illuminates the clearest opportunities for improvement,” he said, noting that Penney’s goal for EBIT margins by 2009 are 9 percent to 9.5 percent. Currently Sears Holdings’ number is 6.9 percent, “the second-lowest margins among the top 10” retailers, Lampert said. “We also lag many of our competitors on a sales- and profit-per-square-foot basis.”

He also cited the success Penney’s has achieved with its off-mall stores as an indicator of the viability of the concept. “We are aware of the success of our off-mall competitors in many of our core businesses,” Lampert wrote, acknowledging that his company has “not found the right formula for Sears Grand as an off-mall offering for Sears.”

Analysts are similarly upbeat about Penney’s prospects for the future.

Jeff Klinefelter of Piper Jaffray said: “The momentum will continue for Penney’s. This moderate, reinvented department store format is emerging to take the place of the regional department store. The confluence of vertically integrated specialty stores and discounters has forced department stores to realign, and this is the result.”
Klinefelter pointed to Penney’s new prototype store format, which employs a “racetrack” layout, centralized checkouts and “hot zones” for key products as  improvements as well.

He also expects Penney’s to benefit from its new inventory flow system. “It’s impressive,” Klinefelter said. “The use of technology over the last five years has changed the economic model and the current and future operating margins. Five years ago I would have said that retailers need a significant increase in inventory for a significant increase in comps. Now, you can achieve higher comps on the same inventory but proper implementation. And Penney’s has been at the forefront of that.”

Analyst Walter Loeb is also keen on Penney’s. “I see value everywhere,” he said during a recent store visit. “I believe J.C. Penney is trying to capture a leadership position through innovative merchandise—private label and national brands—reducing the lead time and making an attempt to replenish the store more frequently. Their philosophy has changed; they’re not stocking the stores with 60 to 70 percent of the seasonal merchandise at the beginning of the season, but staggering it.”

Loeb also pointed to Penney’s attempt to provide more customization by store as a plus. “Tailoring stores shows they’re being much more responsive to their customers,” he said.

And Loeb believes that Penney’s is attracting more customers as a result of the recent conversion of all the former May Co. units to Macy’s. “Penney’s has gained customers in certain areas because the [shopper] did not feel comfortable in the ‘new’ department store, even if the merchandise was similar.”

As a result, Loeb believes that Penney’s “momentum should continue to accelerate, as initiatives such as American Living and Concepts by Claiborne” connect with customers. “Success takes leadership and associates who are convinced by the mission and are enthusiastic because that enthusiasm is contagious to customers,” he concluded.

Deborah Weinswig of Citigroup put out a massive, 32-page report after attending Penney’s two-day analyst meeting in Fort Worth in mid-April. In a nutshell, she concluded that Penney’s new operating-income goal of 12 percent to 12.5 percent by 2011 was “in line with our expectations, and we believe the company could reach the low end of this goal by 2009, driven by its new brand positioning, continued execution in merchandising, Internet growth, square-footage growth (50 stores a year) and strategic inventory flow.”

And Fitch Ratings recently upgraded Penney’s to positive from stable, noting that it expects the retailer to improve its financial standing while maintaining its operating momentum.

Although everything appears to be coming up roses for Penney’s right now, the picture wasn’t nearly that bright just a few short years ago.

The Penney’s reinvention began at the beginning of the decade when turnaround expert and former Federated Department Stores chief Allen Questrom was wooed out of retirement to come on board as CEO. He immediately orchestrated a complete revamping of the retailer, with steps ranging from selling its floundering Eckerd drugstore business to strengthening cash flow, reducing debt and restoring a fashion image.
Questrom’s revamping was so successful that he opted to leave Penney’s about a year before his contract expired, turning the reins over to Ullman in December of 2004. (Ironically, the two had been rivals in the early ’90s when Ullman was running the bankrupt R.H. Macy and was struggling to keep it independent from Federated Department Stores, which at the time was being run by Questrom.)

At Penney’s, Ullman’s challenge was to sustain the momentum that Questrom started by further bolstering its fashion quotient and creating a buzz around the brand. He identified a void in the market—servicing the middle-income, moderate shopper—and worked to execute the burgeoning off-mall strategy while finding additional avenues of growth and synergies in its three channels of distribution: stores, catalog and Internet.

Although Ullman had no direct experience in the moderate retail sector, his skills were well honed by the time he joined Penney’s. In addition to Macy’s, he had been group managing director of luxury giant LVMH Moët Hennessy Louis Vuitton, and CEO of DFS Group.

Over the years he has also been a White House Fellow under President Reagan, vice-president of business affairs at the University of Cincinnati, and managing director and chief operating officer at Wharf Holdings in Hong Kong.

Until signing on at Penney’s, Ullman too had stepped away from active involvement in the retail business, though he was serving on several boards. He had also been sidelined by a medical condition that made traveling and long hours difficult for him. A spinal cord injury has given him some motor issues and he uses a Segway to get around. Yet, he stressed when accepting the post, “there is no medical reason why I can’t perform the job.”

Ullman is now firmly entrenched in Penney’s culture, and although he’s clearly enjoying the company’s recent success, he’s hardly resting on his laurels. Acknowledging that his “goals and aspirations are aggressive,” he maintains that the Penney’s team is up to the challenge. He summed it up this way: “We truly believe retail is a contact sport and you have to take something away from somebody else to win.”

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