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Takeaway: Entering year 7 of margin expansion cycle - inventories look healthy, but cost pressures accelerating. JCP takeaways.

DEPT STORE SIGMA

 

Takeaway: Inventories look healthy coming out of 4Q. But, we think there is more margin headwinds facing this space than a clean balance sheet can solve for. The biggest factor on the gross margin line we're watching is shipping expense. KSS flat out said that a $25 free shipping threshold is unsustainable. TGT set the bar with a $25 minimum. And we think that has a ripple effect on the industry as retailers attempt to keep market share on the web.

Retail Callouts (2/27): Dept Store Sigma, JCP, M, KSS, DDS, TGT, JWN - 2 27 15 chart1

***JCP reduced by a factor of 4 and JWN reduced by a factor of 2

We've never gone more than 5 years without a meaningful correction in EBIT margins. We're now entering year 7 as 2 of the biggest players in the space are making big moves that we think are pretty telling. On the employment front - WMT shook up the employment paradigm, and M, considered the best in breed, goes into investing mode.

  Retail Callouts (2/27): Dept Store Sigma, JCP, M, KSS, DDS, TGT, JWN - 2 27 15 chart2

 

JCP - 4Q14 Earnings

 1. Mixed print, top line looked solid, but gross margins came in below expectations. The market is beating it up over that, but we’re more concerned about the comp. This is the 5th straight quarter where JCP has out comped KSS, and more importantly it lapped last year’s market share gains with another quarter of outperformance. Given what we’ve seen from a litany of retailers this holiday season on the comp line (BONT, BELK, DDS, JCP, ROST, etc.) and the fact that KSS had the most disastrous January last year – we think KSS’ big number is more a function of macro than it is the ‘Greatness Agenda’.

Retail Callouts (2/27): Dept Store Sigma, JCP, M, KSS, DDS, TGT, JWN - 2 27 15 chart3

2. Margins came in 60bps below consensus, but were still up 540 bps. Guidance on that front 50-100bps vs. consensus at 140bps. We’re 100% ok with that. A desperate JCP is much more bearish for a healthy KSS.

 

3. Brick and Mortar sales productivity was up 3% in 2014 at $100 even. That’s still $45 off pre-RonJon peaks. That’s not something we can get excited about. We think that JCP will step up to $115 over the next 4 years, but a) that's a really long time, and b) we’d need to see a runway to $130 to get more positive on this name. We’re not there.