The troubled economy is intensifying pressure on smaller regional department store chains such as Bon-Ton and Gottschalks, which already face challenging competition from Macy’s, J.C. Penney and Wal-Mart.

Last year was a struggle for both Bon-Ton Stores Inc., which saw profits slide more than 75 percent to $11.6 million, and Gottschalks Inc., which posted a loss $12.4 million. Other department stores, such as Belk Inc. and Dillard’s Inc., have yet to weigh in on 2007. But Dillard’s has been pressured by New York-based hedge funds Barington Capital Group and Clinton Group Inc., which own more than 5.3 percent of the chain’s shares, to improve profitability.

Retailers that are trying to basically replicate Macy’s, but on a smaller scale, are creating a “recipe for disaster,” said Mike Moriarty, partner and head of the retail practice at management consultant A.T. Kearney.

“At a certain point, scale makes all the difference,” he said.

But even a national presence hasn’t been enough to shield Macy’s Inc., J.C. Penney Co. and Target Corp. from sluggish results. Wal-Mart Stores Inc., the perceived price leader, is faring better as consumers clutch their pocketbooks tighter.

For the smaller department stores, mergers might not be possible for some time.

Matt Katz, managing director at Alix Partners, a restructuring and advisory firm, said he doesn’t foresee any consolidation opportunity.

For smaller chains, “Where’s the buying power, where’s the leverage? Those regional players don’t have it,” said Katz, noting they are jockeying for attention from producers that have larger retail customers. “They don’t get vendors to showcase or launch product in their doors as readily as others.”

Citing the tight credit market and turmoil on Wall Street, experts expect difficulty in financing almost any but the smallest M&A deals.

“I don’t know that the private equity guys who might fund any consolidation play have the appetite in this market to go after another large retail consolidation,” Katz said. “Selling the equity markets on synergies in this [sector], where pricing pressure is paramount, is going to be tough.”

In addition to the macroeconomic trends, individual companies face their own set of challenges. Bon-Ton, for example, has more than $1 billion in debt after its acquisition of the Carson Pirie Scott chain, and Gottschalks derives more than 80 percent of its volume from California, which has been hit particularly hard by the housing crisis.

This story first appeared in the March 17, 2008 issue of WWD. Subscribe Today.

Fitch Ratings revised its outlook on $1.2 billion of Bon-Ton’s debt to “Negative” from “Stable,” but kept the actual rating a “B,” which is midway through the agency’s junk bond ratings. The change in outlook reflects a drop in both the company’s operating and credit metrics last year.

If Bon-Ton is slower paying down debt, its credit rating might drop, potentially making it more expensive for the company to borrow additional money.

However, Tiffany Co, a credit analyst at Fitch Ratings, said Bon-Ton still has some competitive muscle.

“Their Carson’s stores are a good competitor to Macy’s,” said Co, noting that Bon-Ton stores, depending on location, are also competitive with the national nameplate. “There’s still space in the market for a Bon-Ton. Dillard’s in their own region is quite a strong player.”

Bon-Ton has completed the integration of Carson Pirie Scott and is battening down the hatches for 2008.

“We will operate on a very conservative plan,” chief executive officer Byron Bergren said on a conference call with Wall Street analysts last week.

That means controlling inventories and keeping costs and capital expenditures down. “The retail environment is challenging right now,” Bergren said. “It could improve in 2008 or not. Therefore, we control what we can control.”

The Macy’s integration of the May stores has been challenging and the national chain is going through some growing pains. Macy’s plans to restructure and pare down to four regional operations from seven, eliminating 2,550 positions, including buyers, support staff and senior officials. The Macy’s North, Midwest and Northwest regional divisions are to be folded into the Macy’s East, South and West divisions, respectively.

“We like the way that’s happening,” said Anthony Buccina, Bon-Ton’s vice chairman and president of merchandising, when asked about it during the conference call. “When you are running a Midwest region out of New York City, I think [it is] to our advantage.”

Gottschalks is also planning to keep expenses down and manage inventory prudently, while still trying to draw in customers with merchandising tweaks.

“We are refining our merchandise strategy with a greater focus on key soft-line categories and will soon launch our new, more targeted marketing programs,” said Jim Famalette, chairman and ceo.

  Profit (loss) % change Revenue % change
The Bon-Ton Stores Inc. $11.6 million -75.3 $3.47 billion 0.3
Gottschalks Inc. ($12.4 million) vs. profit $636.4 million -7.4
Source: Company reports