JC Penney boasts long lines at Sephora, but it can't succeed without an apparel fix

Key Points
  • Penney's has focused resources lately on growing its partnership with beauty supplier Sephora and on expanding its own appliances business.
  • This, as the beauty business is booming — makeup retailers like Ulta Beauty, Estee Lauder and Coty have all seen their stocks climb for the year-to-date period.
  • Meanwhile, Sears and hhgregg shuttering more of their stores opens a window of opportunity for Penney's to steal market share in the appliance category.
Shoppers browse appliances at the JC Penney store inside the Roosevelt Field Mall in Garden City, New York.
Saul Martinez | Bloomberg | Getty Images

Lines out the door? In the current environment, it's not often you hear a retailer talking about that kind of demand. But Friday, J.C. Penney's CEO did just that.

"We have seen lines out the door of the mall a block long ... where we rolled out smaller Sephora locations, and we are now in this 100-store expansion of appliances," CEO Marvin Ellison said on Friday's earnings conference call.

J.C. Penney is doubling down on its bets on makeup and appliances, as it looks to lure more people to its stores. But analysts feel these gains aren't enough to make up for sluggish apparel sales.

Department stores have been hit especially hard of late, as shoppers increasingly go online to make their purchases. And Penney's hasn't been immune to this trend. The company is shuttering locations, and its stock hit a fresh multidecade low Monday. On Friday, the company reported its net loss widened in the first quarter and same-store sales dropped more than analysts were expecting.

But the embattled retailer did reaffirm its outlook for fiscal 2017, saying it expects same-store sales — a closely watched metric — to fall within a range of negative 1 percent to positive 1 percent.

Ellison said his team was able to make this decision based on J.C. Penney's latest investments and positive performance in Sephora locations and in the company's home refresh categories, which includes appliances.

"We're very optimistic that [appliances] will work well for us. Just because we have the extended product selection online, we can serve a customer regardless of the units we have on the sales floor," Ellison said.

But not everyone shares this positive view. On Monday, Deutsche Bank analyst Paul Trussell cut Penney's to hold from buy, saying although the strategy to diversify from apparel is the right one, it's not enough to drive same-store sales growth over the next few quarters.

"Especially as the company faces its toughest comparison of the year in 2Q and then laps the appliance rollout in the back half of the year," Trussell said.

J.C. Penney's latest strategy comes at a time when the beauty business is booming — makeup retailers like Ulta Beauty, Estee Lauder and Coty have all seen their stocks perform positively for the month and for the year-to-date period.

Meanwhile, Sears and hhgregg shuttering more of their stores has opened a window of opportunity for Penney's to swoop in and steal market share in the appliance category.

Ellison said Friday that the department-store chain has opened 16 new Sephora locations in its stores during May, and plans to open another 16 Sephora shops in June. By the end of the year, Sephora will be in about 75 percent of Penney's stores, the company said.

Additionally, Penney's said it is in the process of rolling out 100 new appliance showrooms by the end of May — where the company will be able to better market what Ellison calls "one of [Penney's] best businesses." The retailer has 500 appliance showrooms to date.

Penney's said Friday that even though the chain delivered an overall 3.5 percent drop in comparable sales for the first quarter, its Sephora and appliances divisions comped positive.

GlobalData Retail Managing Director Neil Saunders, in an email, described Sephora as "a bigger gun that does give JCP more firepower."

"The impact of having a popular beauty player as part of the offer cannot be underestimated," he continued. "Without it, customer traffic and sales would have tumbled far further and faster; and JCP would have attracted far fewer younger shoppers."

Though, Saunders added, "it will take time for these initiatives to reach maximum potential ... there is much more work to do here if JCP is to turn this into a winning category."

Jefferies analyst Randal Konik said he expects Penney's enhancements of its home refresh business and beauty segment will be more positive for the chain over the long term.

"JCP is taking necessary steps to effectuate its turnaround and is seeing some early traction with its various initiatives," Konik wrote Friday in a note to clients. "But we remain cautious given a challenged [department] store environment and risks involved in a retail turnaround."

Many analysts who cover the company still want to see a revival in its key women's apparel business.

"Despite signs of progress in some key focus areas (Sephora, home, appliances, salons), these benefits are more than offset by persistent weakness in apparel," Evercore ISI analyst Omar Saad wrote in a note to investors last week. Saad points out that women's apparel represents more than 50 percent of Penney's merchandise mix.

By keeping up with trends in the clothing space, growing important initiatives with private brand labels, and increasing its active and casual assortments, Penney's should be able to "reinvigorate" its women's apparel category over time, Saad explained.

"Although sales in women's apparel remained challenged throughout most of the quarter, it did deliver much-improved results in the combined March and April periods versus February," Penney's CEO Ellison told analysts and investors last week.

"We're pleased with our sales performance in active apparel and our dress business. Improvements in these apparel categories bode well for the balance of 2017, as these items become a much larger piece of our business moving forward," he said.

According to Deutsche Bank's Trussell, that is an "appropriate strategic step." However, he has "broader concerns" regarding mall traffic and the shift in apparel sales to off-price and online retailers.

As of Monday's close, shares of Penney's have tanked more than 47 percent for the year-to-date period and are down about 42 percent over the past 12 months.