J.C Penney and the Soft Bigotry of Low Expectations

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J.C. Penney shares have rebounded, but can the company?

That seemed to be the 10-second takeaway after shares rose 7% yesterday despite another horrific earnings report. What's behind the gains?

Wall Street seems to believe that the ailing retailer has finally reached its nadir and that some semblance of a turnaround is taking hold. This comes despite the company missing earnings and revenue estimates by a long shot. Revenue fell 11.9% to $2.66 billion, worse than projections at $2.76 billion, while its adjusted per-share loss dropped to $1.17 after backing out a loss for a tax valuation allowance, worse than estimates at $1.06. A year ago, during a similarly awful quarter, the company lost just $0.37 a share. Penney's has now lost $5.36 per share over the last four quarters, or about $1.2 billion, about 40% of its market value.

Same-store sales, meanwhile, were off by a normally appalling 11.9%, but management noted that comparable sales have improved sequentially over the year, as the second quarter's was 470 basis points better than the first quarter's, and same-store sales improved each month during the last quarter. That progress seemed to be enough to hearten the market.

The company may actually be headed in the right direction now, but with such colossal losses piling up, there's far from any guarantee it will ever turn a profit again.

The Wall Street view
Wall Street loves a good turnaround story, as yesterday's jump in share price made clear. Some of the biggest winners over the last year have been turnaround plays, including Best Buy, Hewlett-Packard, SUPERVALU, Groupon, and Orbitz. Many times these companies aren't any closer to long-term health. It's just that their current prospects simply seem to be less bad than they were before.

Given that logic, J.C. Penney seems to have hit a bottom, as sequential sales should stabilize from this point forward along with the share price, but is that enough of a reason to believe in the company making a real comeback?

The retailer's cash position has improved after taking out a $2.25 billion loan, but the company's negative free cash flow for the first half of the year was over $2 billion, and its total debt now sits near $5 billion. Management promised that free cash flow would be greatly improved in the back half of the year, but it's hard to see the cash burn ending when quarterly losses are greater than $1 a share.

Foolish bottom line
I'm not convinced that J.C. Penney's long-term prospects are any better after its latest report, but newly returned CEO Myron Ullman has put the brakes on the company's free fall and reassured the market that the company is on the right track. Still, it will be a long road ahead. As a salute to Mr. Ullman, I've even closed an underperform CAPScall I had on J.C Penney. If the company can improve its cash position and ameliorate its losses going forward, shares should slowly move back up, but the alarm bells will sound again if those figures aren't improving fast enough. For now, at least, J.C. Penney appears to have escaped the wrath of Wall Street.

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The article J.C Penney and the Soft Bigotry of Low Expectations originally appeared on Fool.com.

Fool contributor Jeremy Bowman has no position in any stocks mentioned. The Motley Fool owns shares of SUPERVALU. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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