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Road to Restructuring: Retailers Drive Toward More Cutbacks

Even without the high drama of a Chapter 11, restructuring continues to be the order of the day across retailing.

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Paul Pressler Gap Inc

Paul Pressler, Gap Inc.

Photo By WWD Staff

Lord & Taylor is closing 32 stores
Alan Lacy Sears Roebuck

Alan Lacy, Sears, Roebuck

Photo By WWD Staff

Allen Questrom JC Penney

Allen Questrom, J.C. Penney

Photo By WWD Staff

NEW YORK — Even without the high drama of a Chapter 11, restructuring continues to be the order of the day across retailing.

“You will see restructuring over all industries,” stated Allen Questrom, chairman and chief executive of J.C. Penney Co. “Whether it’s department stores, airplane manufacturers, telecom, state governments or the federal government, all have to restructure to attain a more effective cost structure. Now it’s become apparent that the power system has to be redone. It’s obviously convoluted, but nobody thought about it until the lights went out.”

At Penney’s, $200 million more in expenses will be cut over the next year and a half, as part of the chain’s five- to six-year turnaround strategy.

The retail restructurings spur further concerns over unemployment, which is a growing political issue in the run-up to next year’s presidential election. Store closures and cutbacks could result in further job losses in the retail sector, which saw year-on-year declines in jobs in August. (For more on August job figures, see page 2).

According to executives and industry observers, possible moves in the months ahead include:

  • At Sears, following the sale of its credit operation, recent remake of the real estate team and announcement of three Great Indoors closings, there’s speculation that 10 percent or more of the remaining store count could be eliminated. Sears currently operates about 1,850 stores.

  • Regionals are likely to consolidate and merge. For example, Bon Ton late last week made a definitive proposal to merge with Elder-Beerman Stores Corp.

  • While the junior sector has already cut back, there’s still plenty of fat there, with companies such as Wet Seal and Charlotte Russe.

  • Gap Inc., which has already shrunk its Gap square footage in major urban areas, could shrink certain Old Navy stores, which are said to be overspaced in many locations.

Retail sources and analysts also cite Kmart, which emerged from Chapter 11 bankruptcy in May after shutting 600 stores and firing 37,000 workers, as well as Mervyn’s, the bankrupt Eddie Bauer, Dillard’s, Stage Stores, Gottschalks, Ann Taylor and Casual Corner as among the chains needing alterations.
“Retailers can’t afford to drag with the stores performing at the bottom of the chain anymore,” said Kathy Bronstein, former chief executive of Wet Seal, who was abruptly restructured out of her own job in February, after just two slumping quarters. Before, if a retailer wanted to renew a lease of a healthy store, he might be egged on by a developer to renew two crummy locations to get the one good one. “Those days are gone,” Bronstein said.

Some of the current restructuring is an aftereffect of 9/11, Questrom noted. “There is also an issue of competition and providing competitive prices,” he added. “The customer wants to buy unique products at affordable prices.” Retailers must cut costs to cut prices.

Following May Co.’s decision last month to close 32 Lord & Taylor units and focus the chain on the Northeast and Midwest, as well as one Famous-Barr and one Jones Store, restructurings at other retailers are expected.

“I think there definitely could be more to come,” said Deborah Weinswig, senior retailing analyst at Smith Barney. “May stock jumped from $20 to $27 on news of cutting stores. That sends a loud message that everyone [on Wall Street] wants stores to be cut. We are overstored.”

“All retailers will be much more focused on inventory management to improve profitability and capital structure, and we will see more focus on store performance,” said Mary Ann Domuracki, director of Financo Restructuring Group. Retailers, she said, will be looking for higher sales productivities, to get more cash out of them, and if they don’t, “They won’t leave them open as long as they used to.”

According to sources, Sears recently fired much of its real estate staff, put in a new team, and could close another 10 to 15 percent of its store base to weed out underperformers and capitalize on the real estate, where there is huge hidden value. More than 50 percent of Sears’ retail locations are owned by the company. The company operations include 850 department stores, 800 automotive centers, 200 hardware stores and 21 Great Indoors, including the three to be closed. Various Sears properties could be redeveloped into offices, movie theaters, hotels, or other types of retailers.
There have been rumors about Sears putting its hardware and automotive stores up for sale as the company tries to focus its business on the department stores and improving apparel sales. Sears declined to comment on the rumors about selling stores, though a spokesman did comment on the real estate team.

“Any changes that were made in the real estate organization would have been part of our top-to-bottom review of the company organization, which had the goal of increasing productivity and to maintain enterprise alignment with strategic priorities, but we don’t talk publicly about specifics.”

Sears does have money, after the sale of its credit operation and financial products to Citigroup for approximately $32 billion in July. While some of the funds may go toward further reducing its debt, Sears is said to be considering purchasing another apparel brand following last year’s bold acquisition of Lands’ End, and could buy back some of its stock, to try to lift the share price. Having sold off its credit operation, which had long been responsible for the bulk of Sears’ profits, there’s increased pressure to revive the full-line department stores.

So Sears has been pumping up its private labels, such as Covington and Canyon River Blues and is adding better visuals to highlight exclusive labels. But it still lacks sufficient pizzazz in its apparel departments. In the late Nineties, Sears executives were so disillusioned by their soft lines they considered trying to merge with Penney’s, as a way to get out of selling apparel and maximizing hard lines. Sears would sell hard lines and Penney’s soft lines. However, concerns about the Federal Trade Commission blocking the plan, since Sears and Penney’s occupy many of the same malls and the massiveness of reinventing the Sears floor discouraged talks with Penney’s.

Penney’s $200 million in expense cuts is “a combination of all kinds of issues — stores, central reorganizing, losing receiving and marking areas,“ Questrom said. Since the late Nineties, as the company moved from a decentralized organization to a centralized one and as new distribution centers and systems were developed, “we had extra people doing both the old way and the new way.” Questrom said the company “always had an expense structure outside acceptable levels to be competitive.”
Penney’s is considering selling its Eckerd drugstore chain, but that’s not a definite, according to Questrom. “We are now in an evaluation process, for the first time.” He said the value of the chain continues to rise each year. “We are going to sell it or keep it, whichever makes the most sense.” If Eckerd does get sold, it’s likely to be sold to a financial buyer or somebody from overseas, rather than another drugstore chain here where there would be too much overlap in locations.

There’s also the possibility that Penney’s might eliminate certain smaller stores that don’t have the space for the chain’s new apparel initiatives. Penney’s has been shutting about 15 to 30 stores for a couple of years, after shutting down 47 in 2001. It now has about 1,040 department stores.

Other retailers such as Federated Department Stores, which is consolidating its Macy’s nameplate onto all of its divisions except Bloomingdale’s, as well as Saks Inc., will continue to prune locations. However, in each of these cases, the store base is expected to remain pretty constant.

Once unheard of, it’s now possible for a Wal-Mart, Costco or Target to move into space formerly occupied by a Sears or Lord & Taylor. Previously, those big discounters were regarded solely as off-the-mall or power center tenants. A Lord & Taylor closing could benefit another May Co. division in the same mall. May Co. typically has a Lord & Taylor on one end of the mall and a Foley’s, Hecht’s or Filene’s, for example, on the other end of the mall.

“We are seeing a pickup of Wal-Mart, Costco and Target moving into the mall,” Weinswig said.

Compared with department stores, there is not as much downsizing occurring in the specialty arena, with Charming Shoppes and Limited Stores having already downsized, though Express could free up some space through the combination of the former Structure men’s wear division into Express, according to analysts.

According to Bronstein, if a store is oversized, such as many believe is the case with Old Navy, it may pay just to wall off an area, hopefully sublease it, rather than keep it as unproductive sales space. The Gap has given no indication of a major restructuring, though the group’s store expansion has slowed for now and the company could be down 2 or 3 percent in square footage for 2003, said analysts.
“Every year you look at what stores are working and what stores are not, and those that aren’t are put on a short list —with a flashing yellow light. If they don’t improve over a year or two, they’re history,” said a source.

Retailers are also looking for stores to be more profitable. They review stores each year, passing grades are getting tougher, and profitability is being pitted against property values. Hypothetically, if a store does $1 million in earnings before interest, taxes, depreciation and amortization and the company is trading at a 5 multiple, that store is worth $5 million. However, if the store’s real estate is worth $10 million or $15 million, it doesn’t make sense to hold on to it.

That’s only one element of the formula for evaluating a store’s future, though. Additional issues factor in, such as whether a store has the potential to increase EBITDA. There are also strategic issues, such as maintaining market share and competitive control of the marketplace. It may be better not to give up space to a competitor.

In addition, relationships with landlords must be considered.

“When you have 10 percent of the chain either breaking even or operating in the red, which is not unrealistic, and 90 percent making a decent profit, you live with that,” Bronstein said. “When the percentage exceeds 10 percent and hits 20 or 25 percent, you start to look at the stores and say, ‘I’ve got to take my chances with the landlord and shut some down.’ When you have a lease, you can’t just walk away from it, but sometimes you are losing so much money that you are willing to take chances.”