JCP -- Kohl's Risk Factors

JC Penney's business has a number of risk factors. On the surface, JC Penney should be in a stable, uninteresting industry, but there are a number of risk factors, and the company's recent difficulties have revealed some of these.

The first major risk factor is that JCP is, ultimately, in the fashion business. Any company that sells clothing faces the singular reality that clothing fashions change, and if at any point the clothes it sells are not in line with the latest fashions, it will be stuck with excess inventory that will have to be sold at a significant discount, in many cases at a loss. Purchasing is therefore a critical element of JCP's business. The company's purchasers must accurately gauge the coming trends for each season. There is a long lead time with respect to fashion trends -- clothes go on sale at least one season ahead and buyers have to put in their orders two seasons ahead. This gap between purchase orders and the season creates risk for any company selling clothes, and a company that does the volumes Penney does is especially at risk. If they have a year where their inventory turnover is lower than expected, and revenues are down, that probably relates back to the purchasing function and a misalignment between their purchasing priorities and the fashions for the year.

Another significant risk for JC Penney is brand loyalty. Normally, a large department store has fairly stable brand loyalty, but JC Penney has learned the hard way in recent years that there is risk related to such loyalty. When you rely on brand loyalty and repeat business, as any large company must, that can create a certain inertia in the business, where management is afraid to make changes. JCP faced this situation a few years ago, when it wanted to shake up the brand, and made a series of decisions that ultimately alienated its core audience. The company was put on the brink of disaster, and changes to its pricing policies in particular lost it many regular customers, without replacing them with new ones. The company has undertaken substantial efforts in the past couple of years to restore brand loyalty (Halkias, 2015). It needs to -- its stores have a tremendous, expensive physical footprint and it needs a lot of traffic in order to pay for that.

A third risk, faced by JCP today, is financial. The company has high fixed costs, and its efforts to transform...

In FY 2014, which ended in January 2014, the company had an operating loss of $1.242 billion. Successive years of operating losses have impacted on the company financially, and even last year it faced an operating loss of $89 million. So despite efforts to restore the company's financials, JCP is still quite vulnerable, something reflected in its low stock price (below $7) and market cap (MSN Moneycentral, 2017). The value of the company's equity has been hammered in recent years, and its retained earnings now sit at negative $3 billion on the balance sheet (MSN Moneycentral, 2017). It is about to finish its next fiscal year at the end of January so it will be interesting to see where it sits at that point.
There are other risk factors that are identified in their Form 10-K, in which a company is obligated to outline its different risks. Some are fairly self-evident, like the risks posed by competition. JCP does operate in a highly-competitive industry. On one hand, it competes directly against Kohl's, Macy's, Nordstrom, Dillard's and other major department stores. On the other hand, the entire department store category competes against smaller shops -- both chains and independent stores -- for the clothing category. JCP's direct competitors are typically large, well-run companies. But the entire department store category is struggling. Where Penney's management snafus a few years back occurred was in trying to branch out because the category is struggling and the audience was aging. JCP tried a lot of things to win younger customers, who prefer smaller stores more directly targeting their needs. The company's efforts failed, and managed to alienate members of their core audience at the same time. So the nature of competition proved highly risky, to the point where any misstep can cause the company to struggle. The best way to overcome this, of course, is by making the right decisions, and that starts with management.

The company is also vulnerable to recession. Mass market retailers are affected by broad economic conditions, so GDP growth and unemployment -- classic macroeconomic measures -- matter to the company. The Great Recession caused all companies in the industry to struggle. The key for JC Penney is that now after its management issues in the past it is more financially vulnerable than usual. A recession now…