As Simon soars, two big mall anchors retrench

December 1, 2012

Simon Property Group Inc. is on a great run, with its stock rising nearly sixfold over the last 44 months. But are Simon investors overlooking the potential fallout from trouble at two of the mall giant’s biggest tenants, Sears and JCPenney?

Sears is the second-biggest anchor at Simon malls, with 157 locations occupying nearly 29 million square feet, filings with the Securities and Exchange Commission show. JCPenney is No. 3, with 111 stores spanning 16 million square feet.

Simon David Simon

Both are trying to pull themselves out of long slides. The news at Sears has gotten steadily worse since hedge-fund manager Eddie Lampert merged Sears and Kmart into Sears Holdings Corp. in 2005. Barron’s last year compared the combining of the two once-iconic chains to “two drunks leaning against each other for support.”

JCPenney, meanwhile, slid into a tailspin after Ron Johnson, the executive who spearheaded Apple’s super-successful retail strategy, became CEO a year ago. He ditched the company’s coupon-heavy marketing, carried out through nearly 600 sales a year, in favor of a “fair and square” strategy featuring everyday low prices.

The strategy hasn’t caused shoppers to flock back to the 110-year-old chain. In the third quarter, sales at stores open at least a year tumbled more than 26 percent—one of the biggest drops ever for a major national retailer.

Analysts say Johnson might have the right remedy. He’s implementing a “store-within-a-store” floor plan across the company, which eventually will carve each location into 100 brand-name boutiques.

Early results are encouraging. So far, about 11 percent of a typical store has the new format, and those areas are generating sales per square foot twice that of the unconverted areas.

But analysts worry time is running out. JCPenney now has reported operating losses for five straight quarters, and the company does not expect to complete the transformation until November 2015.

JCPenney “must find a way to significantly slow the sales decline within the next six months, and if it doesn’t, management’s attempt to ‘bet the company’ could become more problematic,” Credit Suisse analyst Michael Exstein said in a report.

But whatever happens, JCPenney’s struggles, and those of Sears, aren’t really Simon’s problem, said Rich Moore, an analyst with RBC Capital Markets in suburban Cleveland.

Because anchor stores own their own buildings, or pay lower rent when they lease, Sears accounts for only about 0.2 percent of Simon’s rent base, Moore noted. JCPenney is only marginally higher, at 0.6 percent.

“Those stores are big. They take up a lot of space. But they don’t generate a lot of income for Simon,” he said.

Moore said it’s true that anchors historically were crucial for malls, luring shoppers who also would visit the small shops that paid more rent. But he doubts either JCPenney or Sears serve as that magnet today.

In fact, he said, “a lot of landlords would like to get back the department store space that is not working. They would rather put in another department store or small-shop space or put in a lifestyle wing.”

In a conference call with analysts in July, Simon CEO David Simon suggested redevelopment of some Sears space was in the offing.

“The fact of the matter is, Sears needs less space,” he said. “And I think there will be ongoing discussions with us and Sears and the other mall people that will rationalize that space, creating opportunities for both the landlord and Sears.”

He put JCPenney in a far healthier category.

“They have a very talented management team,” Simon said. “They are going through a transformation, but we expect Penney to be a viable mall anchor in a fashion that they have been historically.”

While speculation abounds about the fate of Sears, JCPenney and other department stores, they’re far more resilient than many people realize, Moore said.

Skeptics fail to appreciate the vast value of the real estate they hold, or that when done right, consumers still like the format.

“The real estate they own is a huge asset, and they can have many lives by simply selling some of that real estate to generate cash flow and then trying another approach,” he said.•


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