Shopping missteps

Despite a booming economy, department store stocks have flopped. And management mistakes have hit J.C. Penney Co., Federated Department Stores and Saks even harder.

By MARK ALBRIGHT

© St. Petersburg Times, published August 13, 2000

Dot-com retailers aren't the only ones struggling to figure out new businesses. Some venerable old department store chains are eating crow after a string of new venture blunders.

This should be a hot time for retailers. The economy's humming. Jobs are plentiful. Consumer confidence is high.

Yet department stores have found sales gains tough to come by. Low inflation has kept a lid on price increases, consumer confidence has been uneven, and appealing new fashions have been few and far between. With Alan Greenspan and the Federal Reserve raising interest rates at the first hint of inflation, few investors are betting that the retail sector will keep benefiting from consumers' eight-year spending spree.

So stocks in department stores, always a cyclical industry, are in the dumper again. As a group, department store stocks are trading at about half the price-to-earnings ratio as the rest of the market.

Thanks to management bungling, the shares of J.C. Penney Co. Inc., Federated Department Stores Inc. and Saks Inc. have done even worse for another reason.

All three stumbled big time while marching their chains into new territory. Among them:

Federated Department Stores Inc., which owns Burdines in Florida and a huge regional credit card operation in St. Petersburg, is taking as much as $400-million in charges by the end of this year for bad debts run up by its Fingerhut customers. Federated, which bought Fingerhut last year to get in the catalog and online retail business, acknowledged the delinquency problem was partly its own doing as it learned how to deal with a new type of customer.

Fingerhut's primary customers are low-income families who shop its catalogs to order everything from clothes to toys. Yet the company loosened credit terms and deferred payment plans to entice them to buy more. Many customers ran up tabs they are having trouble paying.

Delinquent accounts only worsened after Federated replaced Fingerhut's closed-end installment payment plans with department store-style revolving credit accounts, with their high interest rates and stiff $20 late fees.

To get a feel for how bad the situation is, consider this: Fingerhut has been forced to establish a reserve for delinquent accounts equal to nearly a fourth of its annual sales of about $1.7-billion.

"We believe we understand the problem, we know what caused it, and we are aggressively taking steps it fix it," said James Zimmerman, Federated chairman and chief executive.

Translation: Federated is tightening its credit terms and cutting deferred interest offers in its Fingerhut catalogs, a decision that will reduce revenues well into 2001. Federated is paying a hefty penalty: Its once-consistent earnings growth will be dragged down by Fingerhut losses for at least two more quarters.

Saks Inc. has decided to annul its 18-month old marriage to Proffitt's Inc., splitting off the luxury retailing chain from its seven lesser-known, struggling department stores that cater mainly to moderate-income customers.

Analysts called the move to spin off chi-chi Saks Fifth Avenue an admission the matchup with moderately priced stores such as Parisian, Younkers and Carson Pirie Scott never really worked. Critics said chairman and chief executive Brad Martin's decision to merge his Proffitt's empire with the prestigious Saks chain two years ago may have been more a matter of ego than merchandising logic.

Now Martin hopes Wall Street will consider the parts of his empire worth more than the whole thing.

Stranger things have happened. Martin paid $1.7-billion for the 61-store Saks operation. Last week, investors gave a market value of $1.4-billion to his entire 250-store company, including Saks Fifth Avenue and seven other department store chains.

J.C. Penney Co. Inc., which has been in a state of almost perpetual reorganization for the past five years, scored a coup with the recent hiring of Allen Questrom, the chief executive who steered Barney's and Federated out of self-induced bankruptcies. But once Questrom gets a grip on how to restore Penney's luster, the old guard no doubt will have some explaining to do about its Largo-based Eckerd Corp.

For the past year JCPenney has been promising to spin off the Eckerd drugstore chain as a separate tracking stock. The idea was that the hidden value of Eckerd would be unlocked if it traded separately from the more troubled Penney's department stores.

All Eckerd needed was two consecutive quarters of sharp performance. Then a couple of dirty little secrets popped out.

First, Penney's disclosed that an audit revealed Eckerd's losses to shoplifters and employee theft were much greater than reported. Once Penney began accounting for losses at the rate Eckerd actually had been experiencing for years, it added a $74-million ball and chain to Eckerd's annual expenses in 1999.

Then in the spring, Penney's closed 289 unprofitable Eckerd stores, about 10 percent of the entire drugstore chain.

Penney had purchased most of the shuttered stores just two years before in its zeal to keep up with acquisition-happy drugstore competitors such as CVS Corp Inc. and Rite-Aid Inc. Eckerd officials said they would have closed most of the 289 stores when they merged Eckerd with Penney's old Thrift Drugs chain in 1998. But the purchases, mostly leftover stores competitors had to dump because of antitrust concerns, went through so quickly that nobody had time to sort out the losers. Now it's become painfully obvious that JCPenney really was not buying profitable stores, just real estate.

By the time Questrom, whose experience is in fashion department stores, turns his attention to Eckerd, his first questions may be: Would it be smarter to forget the whole tracking stock mess or just sell off Eckerd entirely as an unnecessary distraction?

Such things happen when companies stray too far from what they know best.

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