It hasn't been an easy year for department store operators.

Before the housing bust, department stores had been on a winning streak and seemed to dispel the notion that they were a relic of the past. However, the crash in housing prices — and subsequent credit crunch — have done a real number on retail sales in general and hammered the department store sector in particular.

Sales are down, several regional chains have filed for bankruptcy and profits in the latest quarter were less than inspiring. As a result, many department store chains — still the key anchor tenants for most regional malls — have cut back on growth, are considering new store formats or looking to diversify merchandise mixes. “In short, we can't control the economy or gas prices, but what we can control, we are,” said J.C. Penney Corp. CEO Mike Ullman on the Plano, Texas-based company's second quarter earnings conference call.

Management's tone wasn't always so grim. Through the middle of 2007, same-store sales, or sales at locations open at least a year, were stronger at department stores than at many specialty and apparel retailers, according to an analysis of the sector by Columbus, Ohio-based consumer research firm TNS Retail Forward. But since last June, sales overall in the sector rose in only four months out of 12 months and surpassed those of specialty and apparel retailers in just three months. Most analysts and industry watchers say the good old days may not return. “The consumer remains under duress, and their aggressive spending from 2002 to 2006 is unlikely to ever resume,” says Deutsche Bank analyst Bill Dreher Jr.

Second-quarter woes

In the second quarter — the most recent period for which most department stores have reported — profit and sales figures didn't do much to brighten the sector's outlook.

In August, Cincinnati-based Macy's Inc. posted a profit increase of just $1 million in its second quarter. Revenue dipped 3 percent, while same-store sales dropped 2.1 percent. Same-store sales are a big indicator of a retailer's health since they exclude new stores that can skew the comparison from the prior year's results. J.C. Penney Corp., meanwhile, reported its profits dropped 36 percent in the second quarter with sales declining nearly 3 percent. Same-store sales slipped 4.3 percent.

With performance looking bleak, some department store executives say they see salvation in new merchandise and exclusive lines. Others said they would cater to the cash-strapped consumer by opening more outlet-type stores or ramping up their off-mall property development.

Macy's is trying to cater to consumers' needs by localizing its merchandise. The company is concentrating more managers in local markets to make decisions about which merchandise goes on store shelves. That effort is expected to result in $100 million in cost savings per year, but it likely won't have much effect on the company's results until next spring. Meanwhile, apparel sales, the company said, will probably remain weak for the rest of 2008.

Macy's — like so many other chains — is attempting to energize consumer spending by introducing a slew of branded products and apparel lines. Macy's will be the exclusive department-store retailer for Tommy Hilfiger U.S.A. men's and women's sportswear. The company has also developed a partnership with FAO Schwarz to build toy stores in almost 700 Macy's department stores over the next two years.

JCPenney, meanwhile, is focusing on slowing the pace of new store openings and reducing its capital expenditure budget for next year. The company now plans 20 new or relocated stores in 2009, down from the 36 it expects to open in 2008. Both numbers are far lower than the 50 stores a year it had once planned to open.

Ullman says even though the company has scaled back its expansion plans, “we are opening and relocating stores on a selective basis in those areas where we don't have a presence and where the current demand calls for us to have an expanded presence.” The majority of those stores, he says, are off-mall locations. The company is only planning to open one more mall store this year of the 20 they have yet to open. “The fact that our new stores are performing better … than the existing 900-plus stores is a vindication of the fact our new format is more productive and a better offer in the long run and that's why we're so optimistic about becoming the leader in retailing in our sector over the next five years,” he says.

Sears Holding Co., based in Hoffman Estates, Ill., was once the largest department store chain. It has lost that rank and struggled to find an identity, especially since its merger with Kmart in 2005.

Sears has struggled to keep its sales and profits growing mainly because it has had to significantly mark down merchandise to clear it out and make way for newer items. Sears has also been weighed down by a somewhat stale image anchored by its home items like washing machines and vacuum cleaners. To attract more customers, the company is adding a line of street clothes and accessories from rapper LL Cool J. The September launch of the collection will coincide with the release of the rapper's latest album, called “Exit 13.” The launch comes after the company saw its profits drop 44 percent in its most recent fiscal year. It posted a pre-tax loss of $64 million in comparison to a pre-tax gain of $381 million a year ago.

Some chains have fared even worse and have had to go out of business, largely due to an inability to make enough money to pay off debts. As sales have dropped, restructuring debt has become much more difficult due to tightening credit markets. The confluence of both factors has proved to be too much for a growing number of department store chains and other retailers.

According to Thomas Weisel Partners LLC analyst Jim Duffy, 19 mid-sized or larger retail chains have filed for Chapter 11 bankruptcy protection this year. The bankruptcies include four regional department store chains — Knoxville, Tenn.-based Goody's, Hayward, Calif.-based Mervyns, Reading, Pa.-based Boscov's and Lexington, Ky.-based Dawahares. In 2007, only 17 retailers filed for protection for the entire year. Duffy estimates that by the end of 2008, 30 retailers could file for bankruptcy — the highest number in five years.

More bankruptcies, of course, mean more store closures. ICSC estimates that 7 percent more locations will close their doors in 2008 than in 2007. Stores closures wouldn't necessarily be a bad thing for some retailers, particularly once the economy begins to stabilize and consumers ramp up their spending.

But before most department stores think about expanding, most are looking to the back-to-school season for a boost in sales. The National Retail Federation (NRF) expects the average American family with school-aged children to spend $594.24 on back-to-school purchases, compared to $563.49 last year. But much of that increase will likely come from electronics purchases like computers and cell phones.

Deborah Weinswig, a retail analyst with New York City-based Citi, says even if back-to-school spending increases, it may not help department stores, which rely largely on sales of clothing during the back-to-school season. “While households will continue to spend on the back to school necessities, we are concerned that discretionary spending will be limited, especially on apparel, as consumers try to stretch their wallets,” she says.

The NRF survey also indicated that more shoppers plan to go to discount stores like Wal-Mart for their back-to-school necessities. That could leave department stores in the sales doldrums for at least another few months. Ullman says even though the chain has seen a “good response” for its back-to-school merchandise, “we do expect it to be weaker than a year ago and perhaps occurring later.”

TOP 10 DEPARTMENT STORE RETAILERS GROWTH TRENDS
Retailer 2007
U.S. Sales
(in millions)
Share
of Top 10
Total
Stores
Sales-Growth
(2006-2007)
Compound Annual
Growth (2002-2007)
Sales
Stores
Macy's (1) $26,313 23.2 853 -2.4 11.3 13.4
Sears (2) 20,100 17.7 860 -4.4 -2.7 -0.3
JCPenney 19,860 17.5 1,067 -0.2 2.7 0.5
Kohl's 16,474 14.5 929 6.0 12.6 15.2
Nordstrom (3) 8,828 7.8 155 3.1 8.4 2.5
Dillard's 7,207 6.3 326 -5.6 -1.8 4.4
Neiman Marcus Group (4) 4,390 3.9 65 9.0 9.5 6.3
Belk 3,825 3.4 303 3.8 11.3 7.2
Bon-Ton Stores 3,366 3.0 280 0.1 36.4 31.2
Saks (5) 3,230 2.8 102 11.8 -11.4 -22.0
Total Top 10 113,593 4,940 0.0 1.0 2.0
  1. Data include furniture galleries
  2. 2007 sales exclude 75 Sears Grand and SearsEssentials stores
  3. 2007 data exclude two Jeffrey stores from store count, but include their sales; 2002 data exclude five Faconnable boutiques and a shoe store from store count, but include sales
  4. 2007 data include sales for three Cusp stores and the Horchow direct business; 2002 data include sales for Horchow and two Galleries of Neiman Marcus stores
  5. Excludes sales of 75 stand-alone Club Libby Lu stores and 20 Club Libby Lu concessions

Sources: Company reports and TNS Retail Forward