What deluded old fogey said words to this effect: 1) Department stores have the capability to be the real future of retail; 2) Physical stores are overwhelmingly the place where people buy and the same will be true 50 years from now; 3) Although convenient for some, pure online retail is fundamentally a price driven race to the bottom and is not a value creating business model.
Well it's Ron Johnson, the retail superstar responsible for devising and implementing the Apple stores phenomenon – amongst many other successes in the US retail space. During this time (11 years with Apple, in charge of retail) Ron realised the inherent potential existing in department stores. His logic is impeccable – department stores have low costs per sqm of floor space, have the scale to market goods effectively and have central locations. What can go wrong other than a lack of enterprise? Ron Johnson was to find out.
In 2010 renowned value investor Bill Ackman started building a stake in the venerable department store chain JC Penney, eventually reaching 18% of the company. Other value investors and hedge funds also saw an opportunity and by 2012 28% of Penney's stock was in hostile hands. With the company in trouble it soon became apparent that major change was needed, and fast. As luck would have it, America's retail whiz was available after completing his work with Apple. Ron Johnson was so keen he committed $50m of his personal funds into Penney stock and persuaded several leading Apple retail executives to join him in leading JC Penney's revival. All was sweet, and fortunes were to be made.
17 months later the stodgy retailer's stock price was decimated; sales had fallen 25% and Ron Johnson was fired with not much left of his US$50m. Bill Ackman finally sold his stake for a loss of US$700m. On a happy note, JC Penny did not go into bankruptcy and is now recovering slowly. However the question remains – what on earth went wrong?
Retailing is a very subtle industry and best thrives when there are clear and direct messages to the customers. 100 years ago J C Penney himself put it best when he said: "Courteous treatment will make the customer a walking advertisement." This simple maxim was ignored by the revivalists, who went for a rapid transformation and only managed to alienate the solid customer and staff base JC Penney had built up over decades.
Although Ron Johnson continues to maintain department stores have extremely positive prospects he now acknowledges JC Penney was the wrong one to buy into: its customers were addicted to regular 'discounts' and became affronted when Ron introduced 'honest everyday pricing' and no discounts. Also hardly any customers were into tight jeans or hanging out – JC Penney was no Apple.
None of the above is to suggest David Jones Limited (ASX: DJS) or Myer Holdings Ltd (ASX: MYR) face a similar fate. Paul Zahra (DJ's CEO) and Bernie Brooks (Myer CEO) are sensitive and tactical managers who realise department stores are a special breed. Balancing and adjusting a diverse portfolio of brands and products is completely different to marketing an Apple or a Topshop.
Foolish takeaway
Early days yet, however 2014 first-half results demonstrated the momentum underway at David Jones (leaving aside the financial services division) – 38 stores; total sales + 3.8%; like-for-like + 1.1%; store EBIT + 8.3% and margins improved.
By comparison Myer came in at – 66 stores; total sales + 0.3%; like-for-like + 1.2%; store EBIT down 10.5% and margins declined slightly. Both David Jones and Myer expect considerable improvement from 2015 and both pay decent dividends (David Jones 6.2%, Myer 7.6%).
In my view David Jones is the better buy for the medium term and Myer is a prospective income situation. On the merger: I think David Jones has enough to deal with, without effectively buying into the ongoing structural problems of Myer.
