J.C. Penney is launching a major store upgrade program, based on the strong performance of a new prototype. The 1,019-store chain plans to spend $1 billion renovating 250 existing stores and constructing more than 170 new ones by 2009, using a new, flexible “Box One” layout formula. Company officials say 90% of the new stores will be off-mall.

Penney is looking to build on its momentum in the mid-price department store market where archrival Sears is still struggling. “We are stepping up the new store program to a level that will put us in a leadership position in the department store industry,” says Michael Dastugue, senior vice president and director of property development at J.C. Penney Co. Inc. (NYSE: JCP).

The company will open 27 stores this year and approximately 50 stores in each of the following three years. Roughly 80% of the new stores will open in large markets with populations exceeding 1 million people, Dastugue says. Most of the remaining stores will go into midsize markets with populations in the 100,000 to 300,000 range.

On the renovation side, J.C. Penney is making over 50 stores this year and ramping up to 65 or 70 a year through 2009.

Penney, which has come back from an earnings loss of 79 cents per share in 2000 to earnings of $3.83 per share in 2005, is positioned to make these investments because of improved cash flow, says Dastugue. “Utilizing free cash flow for this purpose is the highest and best alternative in terms of both growth and return on capital,” he told analysts gathered at the company’s headquarters earlier this month.

According to an April 26 report by Oppenheimer analyst Bernard Sosnick, JCP’s sales per sq. ft. have improved steadily from $128 in 2000 to $157 per sq. ft. in 2005, a 23% increase in a period when most mall anchor stores saw sales fall 20% to 30%.

The new off-mall stores will be 80,000 sq. ft or 100,000 sq. ft., a format the Plano, Texas-based retailer introduced with three stores in 2003 and fine-tuned at four larger stores opened in 2004. Using a design strategy dubbed Box One, the combination of décor, aisle spacing, adjacencies of departments within the store and other layout factors is adaptable to a number of store sizes and will be used in renovations and new construction alike.

In addition to dictating materials for flooring and displays, Box One determines which departments are adjacent to one another and sets the relationship of sections like junior’s and fashion accessories to one another within a department.

“The concepts are the same, whether it’s in the off-mall store that’s 100,000 sq. ft. or a two-level mall store that we might take over,” Dastugue says. The off-mall stores, which use the Box One concept, are producing sales of $200 per sq. ft. in their first year and may reach $250 as they mature, estimates Sosnick at Oppenheimer. “Their first-year productivity rate is higher than achieved by new Kohl’s stores,” Sosnick writes.

JCP has set a goal to increase its margin of earnings before interest and tax from 8.4% of sales in 2005 to 10% or 10.5% in 2009, but Citigroup analysts say the company could achieve that margin a year ahead of schedule.

The retailer drew Citigroup’s praise for the aggressive development program. “We were pleased that the square footage growth is accelerating to 3% annually beginning in 2007,” Citigroup analysts Deborah Weinswig and Charmaine Tang wrote in an April 21 report.

The expansion will be carried out by a streamlined property development organization, which was formed in 2005 from four previously separate departments at JCP. The company brought its area research team together with the real estate department, store environment designers and the construction group.

“As the company’s growth accelerates and it takes on a greater importance, and the number of projects increases significantly, we believe that bringing these groups under one umbrella will enhance coordination and efficiency and streamline the entire process,” Dastugue says.

Sosnick’s model shows earnings growth of 16% annually to reach almost $6.60 per share by 2009, up from $2.63 in 2005. “[JCP CEO Mike] Ullman aims for Penney to break away from the pack of retail companies, and become the preferred place for Middle America to shop and a leader in retail performance and execution,” Sosnick writes. “We believe Penney will attain these goals.”