Penney Earnings Beat Estimates, but Outlook Disappoints

J.C. Penney Co. (JCP) told investors it's coming out of defensive mode in 2010, launching new brands and remodeling stores to build sales. But it will be a while before it improves enough to pull its debt up to investment-grade levels.

Even while it posted fourth-quarter and year-end results that beat Wall Street's estimates, the department store chain's outlook for 2010 seemed to be too mild for investors' tastes. In a conference call with analysts, Penney's executives were repeatedly quizzed about their 2010 guidance for a comparable-store sales increase in the low-single-digit percentages and earnings per share of $1.55 for the year.The company is planning for long-term profit and market share growth, without factoring in any sharp increases in consumer spending, said CEO Mike Ullman. "I don't expect a knee-jerk pop up in consumer confidence," he said.

Penney posted net income of $200 million in the fourth quarter ended Jan. 31, down 5.6% from the same time last year, and $251 million for the year, down 56.1% from 2008. The drop was due to a one-time pension expense. Factoring that item out, Penney posted earnings of $454 million in the quarter, or 84 cents per share, up 27.9%, and $1.07 per share for the full year. That beat both Penney's management, which estimated between 77 cents and 82 cents for the quarter and $1 to $1.05 for the year, as well as analysts' expectations of 82 cents per share for the quarter, according to the Thomson Reuters consensus estimate.

Focus for 2010: "Drive Sales"

There are signs of improvement in the economy, said Ullman, so Penney will end its Bridge Plan, started two years ago to tide the company over during the economic downturn, and will go back it its long-term plan to build market share and sales.

"Our focus on 2010 is -- put simply -- to drive sales," Ullman said.

Ullman noted MNG by Mango, a "fast fashion" in-store shop developed through a deal with Spanish retailer, will appear in 75 stores in the fall, and 2010 will also mark the launch of Liz Claiborne apparel exclusively at JCPenney stores. Additionally, he said Penney is accelerating the addition of Sephora in-store beauty shops with 75 new stores this year. Adding Mango and Sephora shops will result in remodeling at those stores. Another 20 will be remodeled during the year, he said.

Most of these initiatives won't bear out until the second half of the year. In the meantime, Penney is focused on selling more goods at regular prices and avoiding excessive clearances, said executives.

The Clearance Dilemma

Despite growing profits, Penney has been plagued by weak sales over the last year, especially over the holidays and in January, which management blamed on a shortage of clearance merchandise. CFO Bob Cavanaugh noted that more than half the 6.3% comparable-store sales decline in 2009 was due to lower amounts of clearance merchandise.

"If I had to do over again, we probably could have promoted more aggressively in the month of December," said Ullman. But he added that there's no benefit to Penney in training the customer to wait for markdowns.

"Last year we chose not to chase sales at any cost," said Ullman. That should pay off with profits this year, he added.

Comparable sales in the first quarter are expected to be up in the low-single-digit percentages. February and April sales will be weaker than March, said Cavanaugh.

Analysts Question Credit Rating

Analysts weren't appeased by the modest projections, and they also questioned when Penney will be able to raise its credit rating to investment grade. The retailer has been struggling for years to move up from junk status.

The economy is not helping in that regard, noted Ullman: "Rating agencies are very focused on the macro environment in our sector."

Cavanaugh said Penney now has its best debt-to-capital ratio in 25 years and a record $300 million in cash on hand. When it retires some debt in coming weeks, Penney will have reduced its debt by almost 20% since the end of 2007, and along with a recent stock contribution to help fund its pension plan, "All of this puts us in great shape going forward," he said.

Cavanaugh said the company is focused on restoring that investment grade, but "It will take, as Mike said . . . some time to deliver that performance."

Penney's executives will have more to say about their new five-year plan when they meet investors in New York on April 20.
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